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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For The Fiscal Year Ended December 31, 1995
or
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-1414
PACIFIC BELL
A California Corporation I.R.S. Employer Number 94-0745535
140 New Montgomery Street, San Francisco, California 94105
Telephone - Area Code (415) 542-9000
-------------------
Securities registered pursuant to Section 12(b) of the Act:
See attached Schedule A.
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF PACIFIC TELESIS GROUP, MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION J (1) (a) AND (b) OF FORM 10-K AND
IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO
GENERAL INSTRUCTION J(2).
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SCHEDULE A
Securities registered pursuant to Section 12(b) of the Act*:
Name of each exchange
Title of each class on which registered
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7.250% Debenture due 02/01/08 New York Stock Exchange
Pacific Stock Exchange
7.250% Note due 07/01/02 New York Stock Exchange
6.250% Note due 03/01/05 New York Stock Exchange
7.125% Debenture due 03/15/26 New York Stock Exchange
7.500% Debenture due 02/01/33 New York Stock Exchange
6.875% Debenture due 08/15/23 New York Stock Exchange
6.625% Debenture due 10/15/34 New York Stock Exchange
* Pacific Bell has other securities outstanding not registered
pursuant to Section 12(b) of the Act.
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TABLE OF CONTENTS
Item Description Page
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PART I
1. Business (Abbreviated pursuant to General Instruction J(2))... 1
2. Properties.................................................... 9
3. Legal Proceedings............................................. 9
4. Submission of Matters to a Vote of Security Holders (Omitted
pursuant to General Instruction J(2))
PART II
5. Market for Registrant's Common Equity and Related Stockholder
Matters....................................................... 9
6. Selected Financial Data (Omitted pursuant to General
Instruction J(2))
7. Management's Discussion and Analysis of Results of Operations. 10
8. Financial Statements and Supplementary Data................... 31
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 59
PART III
10. Directors and Executive Officers of Registrant (Omitted
pursuant to General Instruction J(2))
11. Executive Compensation (Omitted pursuant to General
Instruction J(2))
12. Security Ownership of Certain Beneficial Owners and Management
(Omitted pursuant to General Instruction J(2))
13. Certain Relationships and Related Transactions (Omitted
pursuant to General Instruction J(2))
PART IV
14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K...................................................... 60
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PART I
Item 1. Business.
Except for historical information contained herein, this Annual Report on Form
10-K contains forward-looking statements that involve potential risks and
uncertainties. Pacific Bell's (the "Company") actual results could differ
materially from those discussed herein. Factors that could cause or
contribute to such differences include, but are not limited to, those
discussed herein. Readers are cautioned not to place undue reliance on these
forward-looking statements which speak only as of the date hereof. The
Company undertakes no obligation to revise or update these forward-looking
statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
GENERAL
Pacific Bell was incorporated in 1906 under the laws of the State of
California and has its principal executive offices at 140 New Montgomery
Street, San Francisco, California 94105 (telephone number (415) 542-9000).
Through December 31, 1983, the Company was a subsidiary of AT&T Corp.
("AT&T"). Effective January 1, 1984, the Company became a subsidiary of
Pacific Telesis Group (the "Corporation"), one of the seven regional holding
companies ("RHCs") formed in connection with the 1984 divestiture by AT&T of
its 22 wholly owned operating telephone companies ("Bell Operating Companies"
or "BOCs") pursuant to a consent decree settling antitrust litigation
("Consent Decree") approved by the United States District Court for the
District of Columbia (the "Court").
The Company and its wholly owned subsidiaries, Pacific Bell Directory,
Pacific Bell Information Services, Pacific Bell Mobile Services, Pacific Bell
Internet Services, Pacific Bell Network Integration, and others, provide a
variety of communications and information services in California. These
services include: (1) dialtone and usage services, including local service
(both exchange and private line), message toll services within a service area,
Wide Area Toll Service (WATS)/800 services within a service area, Centrex
service (a central office-based switching service) and various special and
custom calling services; (2) exchange access to interexchange carriers and
information service providers for the origination and termination of switched
and non-switched (private line) voice and data traffic; (3) billing services
for interexchange carriers and information service providers; (4) various
operator services; (5) installation and maintenance of customer premises
wiring; (6) public communications services; (7) directory advertising;
(8) selected information services, such as voice mail; (9) Internet access;
and (10) network integration services.
Pacific Bell Directory ("Directory") publishes the Pacific Bell SMART Yellow
Pages(R). It is the oldest and largest publisher of Yellow Pages in
California and is among the largest Yellow Pages publishers in the United
States. As part of its ongoing small business advocacy efforts, Directory
produces an award-winning publication in partnership with the U.S. Small
Business Administration. "Small Business Success," now in its ninth year,
addresses topics of importance to entrepreneurs.
1
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Pacific Bell Information Services ("PBIS") provides business and residential
voice mail and other selected information services. Current products include
The Message Center for home use, Pacific Bell Voice Mail for businesses and
Pacific Bell Call Management, a service that handles incoming business calls
and connects computer databases to answer routine customer questions.
Pacific Bell Mobile Services ("PBMS") was formed in 1994 to pursue
opportunities in personal communications services ("PCS"), a new generation of
wireless services geared to the business and consumer markets. In 1995,
Pacific Telesis Mobile Services, a wholly owned subsidiary of the Corporation,
obtained two licenses to offer PCS services in California and Nevada from the
Federal Communications Commission ("FCC"). PBMS will design, construct,
manage, and market services for the network. Management expects a widespread
offering of PCS services by early 1997.
Pacific Bell Internet Services ("PBI") was formed in 1995 to provide Internet
access services to a broad range of customers in California. PBI began
providing Internet access to large businesses in the third quarter of 1995 and
plans to provide residential service in 1996.
Pacific Bell Network Integration ("PBNI") was formed in 1995 to pursue
opportunities in the network integration business. In 1995, PBNI began
offering network design, installation and maintenance, and network management
services for business data communication networks. PBNI will expand its
service offerings in 1996.
2
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PRINCIPAL SERVICES:
Significant components of the Company's operating revenues are depicted in the
chart below:
% of Total Operating Revenues
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Revenues by Major Category 1995 1994*
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Local Service
Recurring.............................. 28% 22%
Other Local............................ 15% 15%
Network Access
Carrier Access Charges................. 20% 18%
End User & Other....................... 7% 7%
Toll Service
Message Toll Service................... 12% 21%
Other.................................. 1% 1%
Other Service Revenues
Directory Advertising.................. 11% 11%
Other.................................. 6% 5%
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TOTAL....................................... 100% 100%
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* Restated to conform to current year presentation.
The percentages of total operating revenues attributable to interstate and
intrastate telephone operations are displayed below:
% of Total Operating Revenues
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1995 1994
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Interstate telephone operations............ 19% 18%
Intrastate telephone operations............ 81% 82%
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TOTAL...................................... 100% 100%
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3
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CONSENT DECREE
Under the terms of the Consent Decree, all territory served by the BOCs was
divided into geographical areas called "Local Access and Transport Areas"
("LATAs," also referred to as "service areas"). The Consent Decree generally
prohibited BOCs and their affiliates* from providing communications services
that cross service area boundaries; however, the networks of the BOCs
interconnect with carriers that provide such services (commonly referred to as
"interexchange carriers").
The Consent Decree provided that the RHCs shall not engage in certain lines of
business. The Consent Decree provided that the Court might waive the line of
business restrictions (i.e., grant a "Waiver") upon a showing that there was
no substantial possibility that the RHCs could use monopoly power to impede
competition in the market they sought to enter. The Court placed certain
conditions on the Waivers it granted.
Under the Consent Decree, the principal restrictions initially prohibited the
provision of interexchange telecommunications, information services, and
telecommunications equipment and the manufacturing of telecommunications and
customer premises equipment ("CPE"). The telecommunications businesses
originally permitted by the Consent Decree included the provision of exchange
telecommunications** and exchange access services, CPE, and printed directory
advertising. The information services prohibition was lifted in 1991. On
December 3, 1987, the Court interpreted the manufacturing restriction to mean
that the RHCs were prohibited from designing and developing telecommunications
equipment and CPE as well as from fabricating them. In March 1995, the Court
granted a Waiver that allowed the RHCs to provide telecommunications equipment
to unaffiliated parties. In March 1995, the Court also granted a Waiver to
allow the Corporation to own and operate certain facilities to receive video
programming and to provide limited interexchange video services.
On February 8, 1996, President Clinton signed into law the Telecommunications
Act of 1996 (the "Telecommunications Act"). The Telecommunications Act
provides that any conduct or activity previously subject to the Consent Decree
that occurs after February 8, 1996 will be subject to the Communications Act
of 1934 (the "Communications Act"), not the Consent Decree. See discussion
under "Telecommunications Act" below.
___________________________
* The terms of the Consent Decree, with certain exceptions, applied
generally to all BOCs and their affiliates.
** "Exchange telecommunications" under the Consent Decree included toll
services within a service area as well as local service.
4
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STATE REGULATION
As a provider of telecommunications services in California, the Company is
subject to regulation by the California Public Utilities Commission ("CPUC")
with respect to intrastate prices and services, intrastate depreciation rates,
the issuance of securities, and other matters.
The CPUC adopted a new regulatory framework ("NRF"), which is a form of "price
cap" regulation, for the Company in October 1989. In June 1994, the CPUC
reduced the Company's benchmark rate of return from 13.0 percent to
11.5 percent. Earnings between 11.5 percent and 15.0 percent will be shared
equally between the Company and its customers. Earnings above 15.0 percent
will be shared 70.0 percent and 30.0 percent between the Company and its
customers, respectively.
Under "price cap" regulation, the CPUC requires the Company to submit an
annual price cap filing to determine prices for categories of services for
each new year. Price adjustments reflect the effects of any change in
inflation less a productivity factor as well as adjustments for certain
exogenous cost changes. In December 1995, the CPUC issued an order in Phase I
of its second review of the NRF. The order suspended use of the "inflation
minus productivity" component of the price cap formula for 1996 through 1998.
This action freezes the price caps on most of the Company's regulated services
for three years except for adjustments due to exogenous cost changes or price
changes approved through the CPUC's application process.
Phase II of the CPUC's second review was scheduled to begin in January 1996.
The review was to consider the continued applicability of earnings caps,
sharing, and other items. In February 1996, an Assigned Commissioner's Ruling
suggested that this phase be deferred until the next review scheduled for
1998. Comments on the ruling were filed in March 1996. The Company has asked
that certain of these issues be reviewed in 1996.
See Item 7 below, Management's Discussion and Analysis of Results of
Operations ("MD&A") under the headings "CPUC Revenue Rebalancing Shortfall,"
"CPUC Regulatory Framework Review," "Local Services Competition," and
"Universal Service" on pages 15 through 17 for additional information on the
regulation of the Company by the CPUC, which is incorporated herein by
reference.
See MD&A under the headings "Uniform System of Accounts ("USOA") Turnaround
Adjustment," "Revenues Subject to Refund," and "Property Tax Investigation" on
pages 29 through 30, "Change in Accounting for Postretirement and
Postemployment Costs" in Note A to the 1995 Consolidated Financial Statements
on page 41 and "Revenues Subject to Refund" and "Property Tax Investigation"
in Note K to the 1995 Consolidated Financial Statements on pages 54 through 55
for a discussion of other CPUC proceedings, including the application of the
USOA Turnaround Adjustment, regulatory and ratemaking treatment for
postretirement benefits in connection with the adoption of Statement of
Financial Accounting Standards No. 106, and the regulatory and ratemaking
treatment of certain property tax savings, which is incorporated herein by
reference.
5
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FEDERAL REGULATION
The Company is subject to the jurisdiction of the FCC with respect to
interstate access charges and other matters. The FCC prescribes a Uniform
System of Accounts and interstate depreciation rates for operating telephone
companies. The FCC also prescribes "separations procedures," which are used
to separate plant investment, expenses, taxes, and reserves between interstate
services under the jurisdiction of the FCC and intrastate services under the
jurisdiction of state regulatory authorities. The Company is also required to
file tariffs with the FCC for the services it provides. In addition, the FCC
establishes procedures for allocating costs and revenues between regulated and
unregulated activities.
Beginning in 1991, the FCC adopted a price cap system of incentive-based
regulation for local exchange carriers ("LECs"). The Company's access rates
were retargeted to a new 11.25 percent rate-of-return on rate base assets. The
FCC's price cap system provides a formula for adjusting rates annually for
changes in inflation less a productivity factor and changes in certain costs
that are triggered by administrative, legislative, or judicial action beyond
the control of LECs.
In March 1995, the FCC adopted new interim price cap rules that govern the
prices that the larger LECs, including the Company, charge interexchange
carriers for access to local telephone networks. The interim rules require
LECs to adjust their maximum prices for changes in inflation, productivity,
and certain costs beyond the control of the LEC. Under the interim plan, LECs
may choose from three productivity factors: 4.0, 4.7, or 5.3 percent.
Election of the 5.3 percent productivity factor permits the LEC to retain all
of its earnings, whereas election of the lower productivity factors requires
earnings above certain thresholds to be shared with customers. The Company
has chosen the 5.3 percent productivity factor, which enables it to retain all
of its earnings after July 1, 1995.
See MD&A under the heading "FCC Regulatory Framework Review" on page 15 for
additional information on the regulation of the Company by the FCC, which is
incorporated herein by reference.
TELECOMMUNICATIONS ACT
The Telecommunications Act became effective on February 8, 1996. The
Telecommunications Act is the broadest reform of the telecommunications
industry since the Communications Act. The Telecommunications Act essentially
opens all telecommunications markets and prohibits the states from continuing
or establishing any barriers to entry. Once the new law is fully implemented,
consumers will have many new options for their local telephone, long-distance,
and cable television services. The Telecommunications Act will affect the
Company as described below.
6
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The Company may provide out-of-region interLATA service and certain incidental
interLATA services immediately. Before it can provide interLATA service that
originates in California, the Company must open its local markets to
competition, unbundle its network to other competitors, and comply with the
terms and conditions of a "competitive checklist" specified in the
Telecommunications Act. The Company must request authority to offer in-region
interLATA services from the FCC. This service must initially be offered
through a separate affiliate. The separate affiliate requirement expires three
years after approval, unless extended by the FCC.
The Company may only engage in electronic publishing through a separate
affiliate, teaming arrangement, or joint venture. Joint marketing of
electronic publishing services by the electronic publishing affiliate and the
Company is prohibited, with the exception of nonexclusive inbound
telemarketing. The restrictions on electronic publishing expire in early
2000.
The Telecommunications Act allows for the continued provision by the Company
of intraLATA information services, other than electronic publishing, and
intraLATA Internet access. The Telecommunications Act also allows for the
provision by the Company of interLATA information storage and retrieval
services provided by a separate affiliate to and from the Company's databases.
Full interLATA information services and interLATA Internet access may be
provided through a separate affiliate once the Company obtains authority to
provide interLATA services originating in its state. Some Internet services
are also electronic publishing services and are subject to the electronic
publishing restrictions.
The Company may provide a variety of video programming services directly to
subscribers in its service area under regulations that will vary according to
the type of services that are provided. The Company may provide video
services over wireless cable, as a common carrier, as a cable system operator,
as "interactive on-demand services," or as an "open video system." Interactive
on-demand services would allow unscheduled, point-to-point video programming
over the Company's switched network on an on-demand basis. An "open video
system" would allow the Company to select programming for a certain number of
channels if demand exceeds capacity. An "open video system" approved by the
FCC would be subject to reduced regulatory burdens.
The Telecommunications Act allows the Company to collaborate with
manufacturers of telecommunications and customer premises equipment during the
design and development phases. The Company may also engage in research and
enter into royalty agreements in connection with the manufacturing of
telecommunications and customer premises equipment. The Company may
manufacture telecommunications and customer premises equipment, subject to
certain restrictions, once it has obtained authority to provide interLATA
services originating in its state.
7
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COMPETITION
Regulatory, legislative, and judicial actions, as well as advances in
technology, have expanded the types of available communications products and
services and the number of companies offering such services. Various forms of
competition, including price and service competition, are growing steadily and
are already having an effect on the Company's earnings. An increasing amount
of this competition is from large companies with substantial capital,
technological, and marketing resources. Currently, competitors primarily
consist of interexchange carriers, competitive access providers, and wireless
companies. The Company also faces competition from cable television companies
and others. The Company will face significant competition in its provision of
telephone and new services. However, management believes that the Company has
a reputation for high quality services.
Telephone Services Competition
See MD&A under the headings "Local Services Competition" on pages 16 through
17 and "Competitive Risk" on pages 18 through 19 for information on current
developments in telephone services competition that the Company faces, which
is incorporated herein by reference.
Directory Advertising
Other producers of printed directories offer products that compete with
certain Pacific Bell Directory SMART Yellow Pages products. Competition is not
limited to other printed directories, but includes newspapers, radio,
television, and, increasingly, direct mail and directories offered over the
Internet. In addition, new advertising and information products may compete
directly or indirectly with the SMART Yellow Pages. With the introduction of
local exchange competition, Pacific Bell Directory will have to acquire
listings from other providers for its products, and competing directory
publishers may ally themselves with other telecommunications providers.
Internet Access
The Company faces competition in the provision of Internet access from
established Internet access providers, cable television, long-distance, and
other telephone companies.
Network Integration
The Company will face competition in the provision of network integration
services primarily from value added distributors with professional services
and network management capability, including large telecommunication services
providers.
PCS
The Company will face competition in the provision of PCS services from the
holders of the other licenses in such areas. In addition, the Company must
compete with established providers of cellular service.
8
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Item 2. Properties.
The properties of the Company do not lend themselves to description by
character and location of principal units. At December 31, 1995, the
percentage distribution of total telephone plant by major category for the
Company was as follows:
Telecommunications Property, Plant, and Equipment 1995
- ----------------------------------------------------------------------------
Land and buildings (occupied principally by central offices)......... 10%
Cable and conduit.................................................... 41%
Central office equipment............................................. 35%
Other................................................................ 14%
----
Total................................................................ 100%
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At December 31, 1995 the Company's central office equipment was utilized to
approximately 93 percent of capacity.
Substantially all of the installations of central office equipment and
administrative offices are in buildings and on land owned by the Company. Many
garages, business offices, and telephone service centers are in rented
quarters.
As of December 31, 1995, about 25 percent of the network access lines of the
Company were in Los Angeles and vicinity and about 25 percent were in
San Francisco and vicinity. The Company provided approximately 77 percent of
the total access lines in California on December 31, 1995. The Company does
not furnish local service in certain sizable areas of California which are
served by non-affiliated telephone companies.
Item 3. Legal Proceedings.
Not Applicable.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.
The Company has 224,504,982 shares of common stock outstanding without par
value. There is no public trading market for the Company's common stock.
Pacific Telesis Group, incorporated in 1983 under the laws of the State of
Nevada, holds all the Company's outstanding shares.
Additional information about the Company's common shares and dividends paid
monthly thereon is in the Consolidated Financial Statements under "Item 8.
Financial Statements and Supplementary Data," which is incorporated herein by
reference.
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
OVERVIEW
Pacific Bell (the "Company," which when used herein includes its subsidiaries,
Pacific Bell Directory, Pacific Bell Information Services, Pacific Bell Mobile
Services, Pacific Bell Internet Services, Pacific Bell Network Integration,
and others) provides local exchange services, network access, local toll
services, directory advertising, Internet access, and selected information
services in California. The Company is a wholly owned subsidiary of Pacific
Telesis Group (the "Corporation").
The Company's vision is to enrich people's lives through communications and
access to information, education, and entertainment services. Its mission is
to build customer loyalty and be the customer's first choice for
telecommunications and information services; to foster a culture that ensures
employee commitment; and to build value for its shareowners. To be
successful, the Company must continue to balance the needs of its three major
stakeholders: customers, employees, and the Corporation's shareowners.
KEY STRATEGIES
With increasing competition for existing services and the introduction of
local services competition in California effective January 1, 1996, the
Company faces an increasingly competitive marketplace. In response to the
competitive challenge, management has developed three key strategies intended
to provide a consistent, integrated focus for management's decisions and
actions. These overarching strategies are to strengthen the core
telecommunications business, develop new markets, and promote public policy
reform.
Strengthen Core Business
- ------------------------
A strong core business provides the essential foundation to pursue future-
oriented opportunities. To strengthen the core telecommunications business,
management will continue to improve customer service and reduce costs, upgrade
network and systems capability, and retain and expand existing markets through
product and channel innovation.
Improve Customer Service and Reduce Costs
To ensure a high degree of customer satisfaction, the Company interviews more
than 18,000 customers each month to monitor performance. The majority of the
interviews are event driven and designed to measure customer satisfaction with
recent transactions. Also, a portion of employee pay is based on meeting
customer satisfaction targets. The cumulative percentage of the Company's
business and residence market customers responding "good" or "excellent" in
1995 interviews is displayed below.
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Service Service Account
Provisioning Maintenance Servicing
- ----------------------------------------------------------------------------
Business Market (%) 90.8 84.7 89.6
Residence Market (%) 92.0 81.7 90.4
- ----------------------------------------------------------------------------
The Company continues its commitment to total quality management practices as
a proven way to improve processes and increase customer satisfaction. In this
area Pacific Bell has been recognized as a quality leader. In December 1995,
Governor Wilson of California awarded Pacific Bell the Golden State Quality
Award. The award, modeled after the Malcolm Baldrige National Quality Award,
is designed to recognize California companies that continually strive for the
achievement of organizational excellence. The award recognizes companies
whose employees, at all levels, understand their company's vision and mission,
and can relate their own roles to the business strategy. In addition, several
of the Company's special access ordering, provisioning, and maintenance
centers were registered under ISO 9000, an international quality standard.
To prosper in a competitive environment, the Company must continue to provide
outstanding customer service while lowering costs. To improve operational
efficiencies and reduce cost, the Company is implementing core process
reengineering ("CPR"). CPR is a method for achieving significant increases in
performance by fundamentally rethinking basic business processes and systems.
CPR projects have resulted in better, faster customer service, and reduced
costs. For example, a major focus of 1995 was the creation of customer
service centers to improve the response to service activation and repair
calls. With many functions consolidated in the centers, significant time
savings and service improvements have been achieved by reducing hand-offs
between functional work groups. Similarly, the Company has reduced the number
of network operations centers from 25 to two. Each center acts as a fully
functional backup center for the other. Both new centers were operational by
early 1996. The new consolidated centers require approximately 250 fewer
employees to operate than the old centers.
Another effort is the Company's plan to reduce real estate occupancy costs by
as much as 25 percent over five years by encouraging employees to pursue
alternative working arrangements such as telecommuting, virtual offices, and
shared offices. Expense savings will result from consolidating operations,
terminating leases, and eventually selling surplus properties. In 1995, the
Company reduced its annual real estate occupancy costs by over $9 million.
To provide faster customer service, the Company has implemented a new process
called "quick dialtone." Quick dialtone allows the customer to access certain
repair, 911, and business office numbers, even after service is disconnected.
It requires less processing to initiate telephone service and allows the
Company to activate service within about two hours. Eighty percent of
California residences were equipped for quick dialtone in 1995. Quick
dialtone makes it easy for customers to choose Pacific Bell.
As a result of reengineering processes and other efforts, the Company reduced
its workforce 6.0 percent during 1995.
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Upgrade Network and Systems Capabilities
In order to offer the products and services customers want, now and in the
future, the Company continues to invest heavily in improvements to the core
telecommunications network. The Company spent a total of $1.9 billion on the
telecommunications network during 1995. The focus of these investments has
been in the advanced digital technologies discussed below. These technologies
enable the Company to provide new products and services, increase network
quality and reliability, increase transmission speed, and reduce costs.
December 31
-----------------
Technology Deployment 1995 1994
- ---------------------------------------------------------------------------
Access lines served by digital switches................ 73% 65%
Access lines with SS-7 capability...................... 98% 95%
Access lines with ISDN accessibility................... 85% 79%
Miles of installed optical fiber (thousands)........... 467 413
===========================================================================
Signaling System 7 ("SS-7") permits faster call setup and custom calling
services. Integrated Services Digital Network ("ISDN") allows simultaneous
transmission of voice, data, and video over a single telephone line. Digital
switches and optical fiber, a technology using thin filaments of glass or
other transparent materials to transmit coded light pulses, increase the
capacity and reliability of transmitted data while reducing maintenance costs.
In addition, the Company is deploying Synchronous Optical Network ("SONET")
interfaces within the fiber infrastructure. SONET is an international
standard for high-speed fiber optics transmission.
The Company is working with AT&T Corp. to develop and field test an Advanced
Communications Network ("ACN") in California. In addition to providing
advanced telecommunications services, the new network will offer customers
alternatives to existing cable television providers. The ACN technology that
management has selected is a hybrid fiber/coaxial cable architecture. This
technology should be cost effective to deploy and operate, and allow the
Company to achieve significant operational savings. In 1995, management
decided to concentrate development and deployment of the ACN in San Diego and
the San Francisco Bay Area, two of the Company's most competitive markets.
Construction will be slower than originally planned.
Management is continuing to reevaluate its capital program for 1996 but
currently anticipates capital spending in 1996 to be slightly higher than 1995
levels. The capital program includes the cost of upgrading and maintaining
the core telecommunications network and systems capabilities, meeting customer
demand for new access lines, and building the Personal Communications Services
("PCS") network, but excludes most of the costs of the ACN. The Company's
capital expenditures related to a contract with AT&T Corp. for construction of
the ACN are expected to be deferred until 1998. The Company is committed to
purchase these facilities in 1998 if they meet certain quality and performance
criteria. Management now expects the purchase amount to be less than $1
billion in 1998, which is lower than the previous forecast. The Company will
lease certain operational portions of the facilities prior to 1998 during the
construction period.
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Retain and Expand Existing Markets
Stimulating usage of the Company's existing network is the most cost effective
way to increase revenues. The Company is increasing its use of alternative
sales channels and targeted advertising to stimulate usage. Focus areas
include high-growth data markets, voice mail, additional residential lines,
and custom calling services.
The market for high-speed data transmission is growing rapidly. The Company's
ISDN sales more than doubled in 1995. The Company also offers several other
high-speed data transmission products tailored to a customer's specific needs.
Frame Relay technology allows a customer to transmit 126 pages of data per
second and enables the customer to move data quickly between widely dispersed
local area networks. Switched Multimegabit Data Service ("SMDS") allows users
to buy whatever bandwidth they need, and to upgrade it later if desired.
Asynchronous Transfer Mode ("ATM") is a high bandwidth technology that allows
a customer to transmit 50,000 pages of data per second, or to transmit
broadcast-quality video.
The success of the Company's voice mail products continued in 1995. Customers
value such features as the ability of the service to answer the phone even
when they are on the line. They also like remote message retrieval features
and the reliability of the network. Voice mailbox equivalents in service
increased 27 percent in 1995 to about 1.4 million.
Changes in technology and telecommuting are fueling increased demand for
additional telephone lines in the home. The Company began a promotion in
December 1995 designed to increase the number of second residential access
lines. The Company provides approximately 1.7 million residential access
lines that are in addition to the customer's primary line. Customers want
extra lines for data transmission, Internet access, fax machines, and
convenience. Similarly, demand for Custom Calling Services, such as call
waiting, grew more than eight percent in 1995 as customers asked for greater
convenience and more control over their telephone communications.
In May 1995, the Federal Communications Commission ("FCC") established
national rules affecting how carriers, including the Company, may offer
calling party identification services ("Caller ID"). Caller ID displays the
telephone number of the calling party on a device that attaches to, or is part
of, a customer's telephone. The FCC ruling preempts certain of the California
Public Utilities Commission's ("CPUC") restrictions that made providing Caller
ID in California uneconomic. In June 1995, the CPUC appealed the FCC's ruling
to the U.S. Court of Appeals for the Ninth Circuit, which subsequently upheld
the FCC's ruling in January 1996. The ruling is subject to further appeal.
The FCC rules require that a customer notification plan be approved by state
regulators before Caller ID services can be offered. In December 1995, the
CPUC ordered the Company to revise its customer notification plan and allowed
partial recovery of the plan's cost. The Company intends to offer Caller ID
services beginning in June 1996 at the same time it begins passing the calling
party's number on interstate calls in compliance with the FCC rules. To
protect customer privacy, the Company will automatically provide the
capability for per call blocking, which is accomplished by the customer
dialing *67 before dialing the telephone number. The Company will also
provide per line blocking at the customer's request.
13
<PAGE>
Develop New Markets
- -------------------
As competition becomes more fierce in its core telecommunications business,
the Company will rely increasingly on developing new markets to create new
revenue sources. Toward that end, the Company is actively pursuing
opportunities in video services, PCS, and Internet access.
In July 1995, the FCC approved the Company's applications for authority to
offer video dialtone services in specific locations in California. The
approval allows the Company to begin installing the video-specific components
of its ACN. Subject to regulatory approvals, the Company plans to begin
offering video services in San Diego and the San Francisco Bay Area in 1996.
The Telecommunications Act of 1996 terminates the FCC's video dialtone rules
and regulations but allows the continued construction and operation of
previously approved video dialtone systems. (See "Telecommunications
Legislation" on page 15.) The FCC has until July 1996 to issue regulations for
an open video system. Management continues to analyze the impact of the new
legislation on its ACN plans.
In 1995, the Corporation obtained licenses from the FCC to offer PCS to over
30 million potential customers in California and Nevada. PCS is a digital
wireless service offering mobility for both voice and data communications.
Pacific Bell Mobile Services has begun to deploy its network to provide PCS
throughout California and Nevada. The network will incorporate the Global
System for Mobile Communications ("GSM") standard which is widely used in
Europe. Management is working with the industry to resolve issues relating to
hearing aid interference and compatibility common to all digital systems.
Management expects a widespread offering of PCS service by early 1997.
Although management anticipates significant competition, particularly from
established cellular companies, it believes that digital technology and
Pacific Bell's reputation for superior service will be competitive advantages.
In 1995, the Company formed a subsidiary and announced an aggressive campaign
to provide Internet access services to a broad range of customers in
California. One-third of all Internet traffic originates or terminates in
California. One-quarter of the commercial domains on the Internet are
California based. The Company began providing Internet access to large
businesses in the third quarter of 1995 and will provide residential service
in 1996.
Management expects the Company to incur substantial start-up costs in the
development of these new markets, but continues to see these new markets as
attractive investment opportunities.
Promote Public Policy Reform
- ----------------------------
Telecommunications policy reform has been, and will continue to be, the
subject of much debate in Congress, the California Legislature, the courts,
the FCC, and the CPUC. Management supports public policy reform that promotes
fair competition and ensures that the responsibility for universal service is
shared by all who seek to provide telecommunications services. Competition
will bring great benefits to customers by giving them the opportunity to
choose among service providers for their telecommunications needs.
14
<PAGE>
Telecommunications Legislation
In February 1996, the President signed into law a comprehensive
telecommunications bill that eases certain restrictions imposed by the
Communications Act of 1934 and the 1984 Cable Act, and which replaces the 1982
Consent Decree for events subsequent to the date of enactment. Among the
provisions, the new law allows telephone companies and cable television
companies to compete in each others' markets, and permits the former Bell
Operating Companies to apply to the FCC for authority to offer long-distance
service, subject to certain conditions. Long-distance services must be
offered through a separate affiliate. Once the new law is fully implemented,
consumers will have many new options for their local telephone, long-distance,
and cable television services.
FCC Regulatory Framework Review
In March 1995, the FCC adopted new interim price cap rules that govern the
prices that the larger local exchange carriers ("LECs"), including the
Company, charge interexchange carriers ("IECs") for access to local telephone
networks. The interim rules require LECs to adjust their maximum prices for
changes in inflation, productivity, and certain costs beyond the control of
the LEC. Under the interim plan, LECs may choose from three productivity
factors: 4.0, 4.7, or 5.3 percent. Election of the 5.3 percent productivity
factor permits the LEC to retain all of its earnings, whereas election of the
lower productivity factors require earnings above certain thresholds to be
shared with customers. The Company has chosen the 5.3 percent productivity
factor, which enables it to retain all of its earnings after July 1, 1995.
In adopting the interim plan, the FCC required LECs to prospectively reduce
their earnings by 0.7 percent for each year the LEC elected the lower
3.3 percent productivity factor during 1991-94. For the Company this resulted
in a 2.1 percent reduction. The Company has formally contested this reduction
as well as other adjustments associated with the interim plan in the U.S.
Court of Appeals for the District of Columbia ("the Court"). In August 1995,
the Court agreed to expedite review of these adjustments.
The FCC plans to adopt permanent rules in 1996 to replace the interim price
cap plan following a rulemaking proceeding. Management continues to believe
that the FCC should adopt pure price cap regulation and eliminate the
productivity factor, sharing, and earnings caps.
CPUC Revenue Rebalancing Shortfall
In September 1995, the Company filed with the CPUC for $214 million of revenue
increases. The request was to compensate the Company for the revenue
shortfall that resulted from the CPUC's price rebalancing plan that
accompanied the official introduction of toll services competition on
January 1, 1995. Revenue reductions due to lower prices were intended to be
offset by other price increases and by increased network usage generated by
the lower prices. Demand growth as a result of local toll price reductions
fell far short of the level anticipated by the CPUC. As a result, the revenue
neutrality intended by the CPUC was not achieved. Management cannot predict
the outcome of this matter.
15
<PAGE>
CPUC Regulatory Framework Review
In December 1995, the CPUC issued an order in Phase I of its review of the
regulatory framework in California. The order suspended use of the "inflation
minus productivity" component of the price cap formula for 1996 through 1998.
This action freezes the price caps on most of the Company's regulated services
for three years except for adjustments due to exogenous cost changes or price
changes approved through the CPUC's application process. Phase II of the
CPUC's second review was scheduled to begin in January 1996. The review was
to consider the continued applicability of earnings caps, sharing and other
items. In February 1996, an Assigned Commissioner's Ruling suggested that
this phase be deferred until the next review scheduled for 1998. Comments on
the ruling were filed on March 8, 1996. The Company has asked that certain of
these issues be reviewed in 1996. Management continues to believe that the
CPUC should adopt pure price cap regulation and permanently eliminate sharing,
earnings caps, and all other vestiges of rate-of-return regulation.
Local Services Competition
In December 1995, the CPUC issued rules concerning local exchange market
competition. The CPUC authorized 30 other facilities-based competitive local
carriers ("CLCs") to begin providing local phone service in California
beginning January 1, 1996. The new rules provide for interconnection of the
CLCs' networks to the Company's networks. All CLCs must provide access to
emergency services. For the first time, the Company and GTE California are
able to compete in each other's territory.
The CPUC has also announced that competitors who lease lines from LECs for
resale will be able to offer local telephone service beginning in March 1996.
In March 1996 the CPUC adopted a decision specifying terms and conditions for
resale competition. Pending the completion of cost studies, the decision sets
interim wholesale prices for certain services about 17 percent below retail
prices. Wholesale basic residential service will be initially priced 10
percent below retail prices, both of which are below the Company's costs since
basic residential service is subsidized. Management believes that a truly
competitive market cannot be sustained with below-cost pricing.
In November 1995, the Company and MFS Communications Company, Inc. reached
agreement on terms and conditions for the interconnection of their respective
networks and for the use of the Company's local lines. In January 1996, the
Company reached an interconnection agreement under the CPUC's December 20,
1995 preferred framework with Teleport Communications Group. The Company is
also negotiating interconnection agreements with other carriers.
The CPUC expects to resolve remaining issues and issue final rules for
implementing competition in all California telecommunications markets by
January 1, 1997. Issues to be finalized include LEC pricing flexibility, LEC
provisioning and pricing of essential network functions to competitors,
presubscription, the price of interim number portability, universal service,
and final resale prices, terms, and conditions.
16
<PAGE>
Management supports the expansion of local telephone competition and believes
that all markets should be open to all competitors under the same rules at the
same time. Management is concerned that the final local competition rules may
not provide the Company with an opportunity to earn a fair rate-of-return.
The Company has filed testimony showing that the effect of the CPUC's proposed
final local competition rules, taken together with possible unfavorable
decisions on other pending regulatory issues, would deprive the Company of the
opportunity to earn a fair rate-of-return. The filing shows that the proposed
final local competition rules alone could substantially reduce the rate-of-
return on the Company's regulated California operations in 1996, depending on
the outcome of the unresolved issues discussed above.
Universal Service
In a December 1995 report to the California Legislature, the CPUC outlined its
proposal to continue universal telephone service as competition begins in the
local telephone market. The CPUC proposed to define basic service as
including the ability to place and receive calls; access to long-distance
carriers and directory assistance; free access to emergency and customer
services; and other services. The CPUC also proposed establishing a High Cost
Voucher Fund to subsidize companies serving high-cost areas. All carriers
providing local phone service must offer adaptive telephone equipment for the
deaf and disabled and reduced "lifeline" rates for qualified low-income
customers.
If the California Legislature authorizes it to proceed, the CPUC intends to
finalize the definition of basic service, establish a revenue source for the
High Cost Voucher Fund, and identify high-cost areas eligible for subsidy in
June 1996. Management believes that universal service issues should be
resolved before resale competition is authorized; however, resale competition
is scheduled to begin in March 1996, and the final decision establishing
universal service funding is scheduled for August 1996.
On the federal level, the Telecommunications Act of 1996 requires the
establishment of a Federal State Joint Board to make recommendations on the
definition, preservation, and advancement of universal service no later than
November 1996. The FCC must implement these recommendations no later than May
1997. The Telecommunications Act of 1996 permits periodic redefinition of
universal service. It also states that all service providers should
contribute to the preservation and advancement of universal service on an
equitable and nondiscriminatory basis. The Telecommunications Act of 1996
also states that there should be specific, predictable, and sufficient federal
and state mechanisms to preserve and advance universal service. The states
may establish their own universal service policies and regulations provided
that they do not conflict with the federal regulations implemented by the FCC.
17
<PAGE>
COMPETITIVE RISK
Regulatory, legislative and judicial actions, as well as advances in
technology, have expanded the types of available communications products and
services and the number of companies offering such services. Various forms of
competition are growing steadily and are already having an effect on the
Company's earnings. An increasing amount of this competition is from large
companies with substantial capital, technological, and marketing resources.
Currently, competitors primarily consist of interexchange carriers,
competitive access providers, and wireless companies. The Company also faces
competition from cable television companies and others.
Effective January 1, 1995, the CPUC authorized toll services competition. In
May 1995, the CPUC required the Company to permit Centrex customers who
purchase certain optional routing features to route local toll calls to the
carrier of their choice. Management estimates that the Company lost about an
additional five to six percent of the total local toll services market to
competitors in 1995. Management further estimates that, as a result of
official competition and unofficial competitive losses in prior years, the
Company currently serves less than 60 percent of the business toll market. The
CPUC also ordered the Company to offer expanded interconnection to competitive
access providers. These competitors are allowed to carry the intrastate
portion of long-distance and local toll calls between the Company's central
offices and long-distance carriers. As a result of the CPUC order,
competitors may choose to locate their transmission facilities within or near
the Company's central offices.
Effective January 1, 1996, the CPUC authorized local exchange competition. The
CPUC approved 30 companies, including large and well-capitalized long-distance
carriers, competitive access providers, and cable television companies to
begin providing local phone service in California. These companies are
prepared to compete in major local exchange markets and many have already
deployed switches or other facilities. In addition, cable television
companies currently have wires which pass more than 90 percent of the
Company's residential customers and have already announced plans for major
build-outs to compete in the local exchange market. All of the Company's
customers have already chosen a long-distance company, and these companies
have established widespread customer awareness through extensive advertising
campaigns over several years.
Local exchange competition may affect toll and access revenues, as well as
local service revenues, since customers may select a competitor for all their
telecommunications services. Local exchange competition may also affect other
service revenues as Pacific Bell Directory will have to acquire listings from
other providers for its products, and competing directory publishers may ally
themselves with other telecommunications providers. Management estimates the
CPUC's proposed final local competition rules alone could substantially reduce
the rate-of-return on the Company's regulated California operations in 1996,
depending on the outcome of certain unresolved issues in the local competition
rules proceeding.
18
<PAGE>
The unique characteristics of the California market makes the Company
vulnerable to competition. The Company's business and residence revenues and
profitability are highly concentrated among a small portion of its customer
base and geographic areas. Competitors need only serve selected portions of
the Company's service area to compete for the majority of its business and
residence usage revenues. High-margin customers are clustered in high-density
areas such as Los Angeles and Orange County, the San Francisco Bay Area, San
Diego, and Sacramento. Competitors are expected to target the high-usage,
high-profit customers.
Management believes that all markets should be open to all competitors under
the same rules at the same time, and that a truly open competitive market, in
which the Company can compete without restrictions, offers long-term
opportunity to build the business.
RESULTS OF OPERATIONS
The following discussions and data summarize the results of operations of the
Company for 1995 compared to 1994.
%
Operating Statistics 1995 Change 1994
- ----------------------------------------------------------------------------
Capital expenditures ($ millions).. 1,915 17.1 1,635
Total employees at December 31..... 47,202 -6.0 50,207
Employees per
ten thousand access lines*....... 28.8 -8.9 31.6
============================================================================
* Excludes Pacific Bell Directory and Pacific Bell Mobile Services
employees.
The Company reported a loss of $2,391 million for 1995. The reported loss is
due primarily to a non-cash, extraordinary charge to net income during third
quarter 1995 of $3.4 billion, after taxes. The charge resulted from the
Company's discontinued application of special accounting rules for entities
subject to traditional regulation and its change to the general accounting
rules used by competitive enterprises.
Revenue shortfalls also contributed to the decline in earnings. Demand growth
as a result of the January 1995 local toll price reductions fell far short of
the level anticipated by the CPUC. As a result, the revenue neutrality
intended by the CPUC's price rebalancing order was not achieved. Price cap
revenue reductions ordered by the CPUC and the FCC further reduced earnings.
Additional pressure on earnings resulted from incremental labor expense
associated with the severe storms in 1995. Pressure on earnings was mitigated
by the Company's continuing cost containment initiatives.
19
<PAGE>
Management expects that earnings may increase slightly in 1996 compared to
1995 earnings excluding the extraordinary item. Any increase, however, will
be significantly dependent on pending regulatory decisions regarding the terms
and conditions for local competition, and the amount of market share loss as
competition continues to grow. Management anticipates earnings dilution from
the development of new markets and increased local competition, but believes
that the California economy will continue to improve and that cost controls
will continue to succeed. (See "Develop New Markets" on page 14 and "Local
Services Competition" on page 16.) In the long-term, stimulated usage of the
core telephone network, development of new markets, and the continued
expansion of the California economy should provide opportunity for stronger
earnings.
Volume Indicators
- -----------------
%
1995 Change 1994
- ---------------------------------------------------------------------------
Switched access lines at Dec. 31
(thousands)....................... 15,495 3.0 *15,043
Residence....................... 9,691 2.0 *9,499
Business........................ 5,595 4.8 *5,337
Other........................... 209 1.0 *207
ISDN access lines at Dec. 31
(thousands, included in above) 52 136.4 22
Interexchange carrier access
minutes-of-use (millions)........ 58,020 10.8 52,383
Interstate...................... 31,712 3.7 30,581
Intrastate...................... 26,308 20.7 21,802
Toll messages (millions)........... 4,802 8.1 4,442
Toll minutes-of-use (millions)..... 14,488 4.1 13,918
Voice mailbox equivalents at Dec. 31
(thousands)...................... 1,438 27.0 1,132
Custom calling services at Dec. 31
(thousands)...................... 7,169 8.3 6,620
===========================================================================
* Restated.
The total number of access lines in service at December 31, 1995, grew to
15,495 thousand, an increase of 3.0 percent for the year, up from 2.9 percent
in 1994. The growth rate in business access lines was 4.8 percent in 1995, up
from 4.2 percent in 1994. The growth in business access lines reflects
increased employment levels in California. The number of ISDN lines in
service grew to 52 thousand, an increase of 136.4 percent for the year, as
customers increased telecommuting and demanded faster data transmission and
Internet access. The residential access line growth rate declined to
2.0 percent for 1995, from 2.2 percent in 1994. The lower residential growth
rate compared to the business growth rate reflects weak residential
construction in California.
20
<PAGE>
Access minutes-of-use represent the volume of traffic carried by interexchange
carriers over the local network. Total access minutes-of-use for 1995
increased by 10.8 percent over 1994. The increase in access minutes-of-use
was primarily attributable to economic growth and the effect of toll services
competition. The official introduction of toll services competition in January
1995 had the effect of increasing intrastate access minutes-of-use. This
phenomenon occurs because the Company provides access service to competitors
who complete local toll calls over the Company's network.
Toll messages and minutes-of-use are comprised of Message Telecommunications
Service and Optional Calling Plans ("local toll") as well as WATS and
terminating 800 services. In 1995, toll minutes-of-use increased by
4.1 percent compared to an increase of 1.4 percent for 1994. The increase was
driven primarily by economic growth as well as lower prices. On January 1,
1995, the Company lowered the price of its local toll services by an average
of 40 percent. The Company also began offering new discount calling plans.
Residential customers receive an automatic 15 percent off toll charges above
five dollars per month while businesses receive an automatic 20 percent off
toll charges over $15 per month. High-volume customers can receive even
larger discounts. Price decreases stimulated demand slightly but the increase
fell far short of levels predicted in the CPUC's order.
For a discussion of voice mail products and custom calling services, see page
13 under "Retain and Expand Existing Markets."
A growing California economy should allow current volume growth trends to
continue into 1996. However, this may be completely or partially offset by
competitive losses due to the CPUC's authorization of local competition
beginning January 1, 1996.
Operating Revenues
- ------------------
($ millions) 1995 Change 1994
- ----------------------------------------------------------------------------
Total operating revenues...... $8,862 -$205 $9,067
-2.3%
- ----------------------------------------------------------------------------
Revenues were reduced from 1994 primarily because demand growth as a result of
lower prices was less than assumed in the CPUC-ordered price rebalancing.
Revenues were also reduced because of price cap revenue reductions ordered by
the CPUC and FCC under incentive-based regulation as well as the effects of
toll services competition.
21
<PAGE>
Effective January 1, 1995, the CPUC allowed long-distance companies and others
to officially compete with the Company in providing local toll services in
California. That decision also rebalanced prices for most of the Company's
regulated services so that the Company could remain competitive in the new
environment. The CPUC intended this decision to be initially revenue neutral.
Revenue reductions due to lower prices were intended to be offset by other
price increases and by increased network usage generated by the lower prices.
Although the Company observed some increased usage during 1995, calling
volumes were far below levels forecasted by the CPUC and far below levels
necessary to achieve revenue neutrality.
The decreases in total operating revenues from price rebalancing and price cap
orders were partially offset by a net increase in customer demand of
$318 million. Comparative revenues were also increased by a CPUC-ordered
refund of $27 million in the second quarter of 1994 related to the Company's
payment processing system.
Primary factors affecting revenue changes are summarized below:
Total
Price Change
Price Cap Customer from
($ millions) Rebalancing Orders Misc. Demand 1994
- ----------------------------------------------------------------------------
Local service................ $379 -$125 $ 79 $ 24 $357
Network access:
Interstate.................. 20 -46 75 72 121
Intrastate.................. -213 -17 3 203 -24
Toll service................. -616 -48 -53 -57 -774
Other service revenues....... 15 -1 25 76 115
----- ----- ----- ----- -----
Total operating revenues..... -$415 -$237 $129 $318 -$205
============================================================================
Local service revenues include basic monthly service fees and usage charges.
Fees and charges for custom calling services, coin phones, installation, and
service connections are also included in this category. The $24 million
increase in customer demand for local service is the result of the 3.0 percent
growth in access lines and the 8.3 percent growth in custom calling services,
such as call waiting, generated by the improved economy in California.
Network access revenues reflect charges to interexchange carriers and to
business and residential customers for access to the Company's local network.
The $72 million increase in interstate network access revenues due to customer
demand reflects increased interexchange carrier access minutes-of-use, as well
as increased access lines. The $203 million demand-related increase in
intrastate network access revenues also resulted from growth in access
minutes-of-use. The official introduction of competition in the local toll
market in January 1995 had the effect of increasing access usage revenues.
22
<PAGE>
Toll service revenues include charges for local toll as well as WATS and
800 services within service area boundaries. The decreases in customer
demand-related toll service revenues primarily result from competition. The
Company has lost and continues to lose WATS and 800 service business to
interexchange carriers who have the competitive advantage of being able to
offer these services both within and between service areas. Management
estimates that the Company lost an additional five to six percent of the local
toll services market to competitors in 1995. Partially offsetting these
reductions were increased usage revenues resulting from general economic
growth and lower prices.
Other service revenues are generated from a variety of services including
directory advertising, information services, and billing and collection
services. Other service revenues for 1995 include an increase in information
service revenues of $35 million, chiefly due to the success of the Company's
business and residential voice mail products. Voice mailbox equivalents
increased 27 percent in 1995.
Looking ahead, in addition to the effects of local services competition on the
Company's revenues in 1996, the FCC's annual access charge order that took
effect August 1, 1995, required the Company to reduce revenues about $123
million annually.
Operating Expenses
- ------------------
($ millions) 1995 Change 1994
- ----------------------------------------------------------------------------
Total operating expenses...... $6,939 $0 $6,939
-
- ----------------------------------------------------------------------------
Total operating expenses for 1995 in comparison to 1994 were flat, which
reflects the Company's continuing cost reduction efforts and reduced
settlements expense, despite increased depreciation and software expenses and
the costs resulting from severe storm damage in early 1995. Primary factors
affecting expense changes are summarized below.
23
<PAGE>
Pacific Bell Expenses
(excluding subsidiaries) Total
----------------------------------- Change
Salaries Employee Settle- Subsid- from
($ millions) & Wages Benefits ments Misc. iaries 1994
- ----------------------------------------------------------------------------
Cost of products and
services............. -$21 -$38 -$79 $ 50 $ - -$88
Customer operations and
selling expenses..... -23 -17 - -2 22 -20
General, administrative,
and other expenses... -41 4 - - 71 34
Property & other taxes. - - - 1 - 1
Depreciation and
amortization........ - - - 69 4 73
------ ------ ------ ------ ------ ------
Total operating
expenses............. -$85 -$51 -$79 $118 $97 $ 0
============================================================================
At Pacific Bell, excluding subsidiaries, salary and wage expense decreased
$85 million in 1995, primarily as a result of a net workforce reduction of
3,114 employees. The effect of the declining workforce was partially offset
in 1995 by increased overtime for storm and flood repairs and by a $29 million
increase related to higher compensation rates. Management expects salary and
wage expense to decline further in 1996 due to continued force reduction
programs (see "Status of Restructuring Reserve" on page 27).
At Pacific Bell, excluding subsidiaries, employee benefits expense decreased
$51 million primarily due to the Company's ongoing health care cost-reduction
efforts and continued force reduction programs. Management expects employee
benefits expense to decline further in 1996 due to the continued force
reduction programs and changes in actuarial assumptions.
Decreases in salaries and wages and employee benefits expense forecast for
1996 will be partially offset by increases associated with new labor
agreements. The new agreements were effective August 1995 and feature a 10.5
percent wage increase, a 14 percent pension increase, and other increased
benefits over three years. Management estimates that the agreements will
result in increased costs of approximately $550 million over three years. This
estimate does not include savings that may result from the continued force
reduction programs.
Pacific Bell's settlements expense for 1995 decreased primarily due to the
CPUC-ordered price rebalancing, which eliminated reimbursements to certain
other local exchange carriers for calls terminating in their territories.
Pacific Bell's miscellaneous cost of products and services increased primarily
due to increased software purchases in 1995.
24
<PAGE>
Depreciation expense increased $73 million in 1995 primarily due to higher
depreciation rates ordered by the CPUC effective January 1, 1995, and higher
telecommunications plant balances. Depreciation expense is expected to
increase in 1996 due to the continuing upgrade of the core telecommunications
network. (See "Upgrade Network and Systems Capabilities" on page 12.)
Pacific Bell subsidiaries' general and administrative expense increased in
1995 primarily due to non-recurring software expenses.
Interest Expense
- ----------------
($ millions) 1995 Change 1994
- ----------------------------------------------------------------------------
Interest expense ................. $410 -$29 $439
-6.6%
- ----------------------------------------------------------------------------
Interest expense decreased in 1995 primarily due to interest expense
associated with a CPUC refund order in 1994. The decrease was partially
offset by interest expense associated with increased short-term borrowings.
Interest expense in 1996 is expected to decrease due to the reclassification
of interest during construction from an item of miscellaneous income to a
reduction in interest expense associated with the discontinuance of Statement
of Financial Accounting Standards No. ("SFAS") 71, "Accounting for the Effects
of Certain Types of Regulation." (See Note B - "Discontinuance of Regulatory
Accounting - SFAS 71" on page 41.)
Miscellaneous Income
- --------------------
($ millions) 1995 Change 1994
- ----------------------------------------------------------------------------
Miscellaneous income.......... $25 $22 $3
-
- ----------------------------------------------------------------------------
Miscellaneous income increased in 1995 primarily due to interest income of
approximately $24 million from tax refunds received in 1995 related to prior
years and unrealized gains on trust assets under an executive compensation
deferral plan. These increases were partially offset by bond redemption costs
associated with the redemption of debentures. Miscellaneous income is
expected to decrease in 1996 due to the reclassification of interest during
construction from an item of miscellaneous income to a reduction in interest
expense associated with the discontinuance of SFAS 71.
25
<PAGE>
Income Taxes
- ------------
($ millions) 1995 Change 1994
- ----------------------------------------------------------------------------
Income taxes......................... $569 -$52 $621
-8.4%
Effective tax rate (%)............... 37.0 36.7
- ----------------------------------------------------------------------------
The decrease in income tax expense for 1995 was primarily due to lower pre-tax
income.
Extraordinary Item
- ------------------
The Company historically has accounted for the economic effects of regulation
in accordance with the provisions of SFAS 71. Under SFAS 71, the Company
depreciated telephone plant using lives prescribed by regulators and, as a
result of other actions of regulators, deferred recognizing certain costs or
recognized certain liabilities (referred to as "regulatory assets" and
"regulatory liabilities").
Effective third quarter 1995, management determined that, for external
financial reporting purposes, it is no longer appropriate for the Company to
continue to use the special SFAS 71 accounting rules for entities subject to
traditional regulation. Management's decision to change to the general
accounting rules used by competitive enterprises was based upon an assessment
of the emerging competitive environment in California. Prices for the
Company's products and services are being driven increasingly by market forces
instead of regulation.
The discontinued application of SFAS 71 required the Company, for external
financial reporting purposes, to write down the carrying amount of its
telephone plant and to eliminate its regulatory assets and liabilities. As a
result, the Company recorded in 1995 a non-cash, extraordinary charge of $3.4
billion, which is net of a deferred income tax benefit of $2.4 billion. The
telephone plant write-down portion of the charge reflects a pre-tax increase
in accumulated depreciation of approximately $4.8 billion to recognize shorter
estimated lives in a competitive market. The extraordinary charge also
includes a pre-tax adjustment of $962 million to eliminate regulatory assets
and liabilities. The discontinuance of SFAS 71 was made in accordance with
SFAS 101, "Accounting for the Discontinuance of Application of FASB Statement
No. 71." (See also Note B - "Discontinuance of Regulatory Accounting -
SFAS 71" on page 41.)
In future years, the discontinuance of SFAS 71 is not expected to materially
affect depreciation expense, net income, or cash flow. This action will not
affect the Company's planned network investments. The discontinuance of SFAS
71 is a change for external financial reporting only and has no effect on
customers.
26
<PAGE>
Cumulative Effect of Prior Year Accounting Change
- -------------------------------------------------
Effective January 1, 1993, the Company adopted SFAS 112, "Employers'
Accounting for Postemployment Benefits." SFAS 112 require a change from cash
to accrual accounting by recording a cumulative catch-up-charge at
implementation. A one-time, non-cash charge was recorded against earnings of
$148 million, which is net of a deferred income tax benefit of $103 million.
The annual periodic expense does not differ materially from expense under the
prior method.
Status of Restructuring Reserve
- -------------------------------
In 1991, a $201 million reserve was established for the cost of management
force reduction programs through 1994. A balance of $77 million remained at
the end of 1993. An additional $1,020 million reserve was established in
December 1993 to record the incremental cost of force reductions associated
with restructuring the Company's business processes through 1997. This
restructuring was expected to allow the Company to eliminate more than
14,000 employee positions from 1994 through 1997. After considering new
positions expected to be created, a net reduction of approximately
10,000 positions was anticipated. The Company also expects to relocate
approximately 10,000 employees as it consolidates business offices, network
facilities, installation and collection centers, and other operations.
Pacific Bell's gross force reductions under the restructuring plan, excluding
subsidiaries, totaled 4,187 employees in 1995. Total gross force reductions
for the first two years of the plan, 1994 and 1995, totaled 10,039. Net force
reductions were 3,114 for 1995 and 7,242 for the two-year period 1994 and
1995. Management now believes both total gross and net force reductions
through 1997 are likely to exceed its original forecasts.
Annual cash savings are expected to reach approximately $1 billion when the
restructuring is completed. In 1995, expense savings due to the restructuring
totaled approximately $500 million primarily from savings in labor costs due
to cumulative force reductions since restructuring began.
Charges to the restructuring reserve in 1995 totaled $600 million including
$219 million for the cost through 1997 of enhanced retirement benefits
negotiated in the 1995 union contracts. These costs will be paid from pension
fund assets and do not require current outlays of the Company's funds.
Because the cost of enhanced retirement benefits was recognized in full in
1995, charges to the restructuring reserve in 1996 and 1997 are expected to be
approximately $100 million less in each of the respective years than the
original forecast.
27
<PAGE>
The table below sets forth the status and activity in the reserve.
($ millions) 1995 1994 1993
- ------------------------------------------------------------------------
Reserve for force reductions and restructuring:
Balance - beginning of year.............. $ 819 $1,097 $ 101
Additions................................ - - 1,020
Charges: cash outlays ................... -381 -216 -24
noncash ........................ -219 -62 -
------------------------
Balance - end of year.................... $ 219 $ 819 $1,097
========================================================================
BOND RATINGS
In May 1995, Duff and Phelps, Inc. lowered the rating of the Company's bonds
from Double-A ("AA") to Double-A-Minus ("AA-"). The rating action reflected
price cap revenue reductions, toll services competition, and proposed interim
rules on local services competition. The rating action also reflected the
expected financing requirements of the Company's ACN and PCS networks.
In August 1995, Standard and Poor's Corporation removed bond and commercial
paper ratings of the Company from "CreditWatch," where they were placed in May
1995 following the release by the CPUC of its proposed interim rules on local
services competition. Standard & Poor's Corporation stated that the long-term
rating outlook for the Company is negative.
In March 1996, Moody's Investors Services, Inc. ("Moody's") placed the long-
term debt rating of the Company under review for possible downgrade. Moody's
expressed concerns about external financing requirements associated with the
Company's ACN and wireless initiatives.
The following are commercial paper and bond ratings for the Company.
- ---------------------------------------------------------------------------
Moody's Investors Standard & Duff and
Commercial Paper: Services, Inc. Poor's Corp Phelps, Inc.
- ------------------- ----------------- ----------- ------------
Pacific Bell Prime-1 A-1+ Duff 1+
Long and Intermediate-
Term Debt:
- ----------------------
Pacific Bell Aa3 AA- AA-
- ---------------------------------------------------------------------------
The above ratings reflect the views of the rating agencies and are subject to
change. The ratings should be evaluated independently and are not
recommendations to buy, sell, or hold the securities of the Company.
28
<PAGE>
ADOPTION OF NEW ACCOUNTING STANDARDS
- ------------------------------------
Under SFAS 123, "Accounting for Stock-Based Compensation," companies are
required to provide new disclosures about stock options based on their fair
value at the date of the grant. This new rule is required in financial
statements for fiscal years beginning after December 15, 1995. SFAS 123
provides for an option to disclose pro-forma effects of stock compensation on
net income and earnings per share or charge stock compensation to earnings.
The Company intends to adopt the disclosure-only alternative in its December
31, 1996 consolidated financial statements.
PENDING REGULATORY ISSUES
Uniform System of Accounts ("USOA") Turnaround Adjustment
- ---------------------------------------------------------
In May 1995, the Company filed an application with the CPUC to eliminate the
USOA Turnaround Adjustment effective January 1, 1995. This Turnaround
Adjustment is a vestige of traditional rate-of-return regulation and has been
in effect since 1988. Because of the adjustment, the Company's revenues have
been reduced by over $23 million each year since 1988. These adjustments were
intended to reflect annual revenue requirement reductions resulting from the
CPUC's adoption of a capital-to-expense accounting change in 1988. The CPUC
held evidentiary hearings in October 1995 addressing whether the USOA
Turnaround Adjustment should be eliminated. The Company has strongly
recommended that this adjustment be discontinued effective January 1, 1995,
which would result in a one-time revenue increase of $23 million for 1995.
The CPUC's Division of Ratepayer Advocates has proposed that the Company be
ordered to permanently reduce its revenues by $106 million effective January
1, 1996. Another intervenor has proposed that the Company should be ordered
to reduce its revenues permanently by $112 million over the next ten years and
reduce its revenues by an additional $43 million on January 1, 1996. It is
possible that the CPUC could decide this issue in the near term, and that the
decision could have a material adverse effect on the Company.
Revenues Subject to Refund
- --------------------------
In 1992, the CPUC issued a decision adopting, with modification, SFAS 106,
"Employers' Accounting for Postretirement Benefits Other Than Pension," for
regulatory accounting purposes. Annual price cap decisions by the CPUC
granted the Company approximately $100 million in each of the years 1993-1996
for partial recovery of higher costs under SFAS 106. However, the CPUC in
October 1994 reopened the proceeding to determine the criteria for exogenous
cost treatment and whether the Company should continue to recover these costs.
The CPUC's order held that related revenues collected after October 12, 1994,
are subject to refund plus interest. These related revenues totaled about
$122 million at December 31, 1995. Management believes postretirement
benefits costs are appropriately recoverable in the Company's price cap
filings. It is possible that the CPUC could decide this issue in the near
term, and that the decision could have a material adverse effect on the
Company.
29
<PAGE>
Property Tax Investigation
- --------------------------
In 1992, a settlement agreement was reached between the State Board of
Equalization, all California counties, the State Attorney General, and
28 utilities, including the Company, on a specific methodology for valuing
utility property for property tax purposes. The CPUC opened an investigation
to determine if any resulting property tax savings should be returned to
customers. Intervenors have asserted that as much as $20 million of annual
property tax savings should be treated as an exogenous cost reduction in the
Company's annual price cap filings. These intervenors have also asserted that
past property tax savings totaling as much as $60 million plus interest should
be returned to customers. Management believes that under the CPUC's
regulatory framework, any property tax savings should only be treated as a
component of the calculation of shareable earnings. In an Interim Opinion
issued in June 1995, the CPUC decided to defer a final decision on this matter
pending resolution of the criteria for exogenous cost treatment under its
regulatory framework. The criteria are being considered in a separate
proceeding initiated for rehearing of the CPUC's postretirement benefits other
than pensions decision. It is possible that the CPUC could decide this issue
in the near term, and that the decision could have a material adverse effect
on the Company.
SALE OF BELLCORE
In April 1995, Bellcore announced a decision by its owners to pursue the sale
of Bellcore. Bellcore is a leading provider of communications software and
consulting services. It is owned by the Company and six of the telephone
regional holding companies formed at the divestiture of AT&T Corp. in 1984.
The owners have retained two investment banking firms in connection with the
proposed sale. A final decision regarding the disposition of interests and
the structure of such a transaction has yet to be determined. Any transaction
will be subject to necessary approvals. (See Note M - "Additional Financial
Information" on page 56.)
30
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF MANAGEMENT
The management of Pacific Bell is responsible for preparing the accompanying
financial statements and for their integrity and objectivity. The statements
have been prepared in accordance with generally accepted accounting principles
applied on a consistent basis and are not misstated due to material fraud or
error. In instances where exact measurement is not possible, the financial
statements include amounts based on management's best estimates and judgments.
Management also prepared the other information contained in this annual
financial review and is responsible for its accuracy and consistency with the
financial statements.
The Company's financial statements have been audited by Coopers & Lybrand
L.L.P., independent accountants, whose appointment has been ratified by the
Corporation's shareowners. Management has made available to Coopers & Lybrand
L.L.P. all the Company's financial records and related data, as well as the
minutes of directors' meetings. Furthermore, management believes that all of
its representations made to Coopers & Lybrand L.L.P. during their audit are
valid and appropriate.
Management has established and maintains a system of internal control that
provides reasonable assurance as to the integrity and reliability of the
financial statements, the protection of assets from unauthorized use or
disposition, and the prevention and detection of fraudulent financial
reporting. The system of internal control provides for appropriate division
of responsibility and is documented by written policies and procedures that
are communicated to employees with significant roles in the financial
reporting process and are updated as necessary. Management continually
monitors the system of internal control for compliance, and maintains a strong
internal auditing program that independently assesses the effectiveness of the
internal controls and recommends improvements when necessary. In addition,
as part of their audit of the Company's financial statements, Coopers
& Lybrand L.L.P. have obtained a sufficient understanding of the internal
control structure to determine the nature, timing and extent of audit tests to
be performed. Management has considered the internal auditors' and Coopers
& Lybrand L.L.P.'s recommendations concerning the Company's system of internal
control and has taken actions that it believes are cost-effective under the
circumstances to respond appropriately to these recommendations. Management
believes that the Company's system of internal control is adequate to
accomplish the objectives discussed.
31
<PAGE>
Financial Statements and Supplementary Data (cont'd)
Management also recognizes its responsibility to foster a strong ethical
climate that enables the Company to conduct its affairs according to the
highest standards of personal and corporate conduct. This responsibility is
characterized and reflected in the Company's code of corporate conduct, which
is publicized throughout the Company. The code of conduct addresses, among
other things: potential conflicts of interests; compliance with domestic
laws, including those relating to foreign transactions and financial
disclosure; and the confidentiality of proprietary information. The Company
maintains a systematic program to assess compliance with these policies.
The Audit Committee of the Board of Directors is responsible for overseeing
the Company's financial reporting process on behalf of the Board. In
fulfilling its responsibility, the Committee recommends to the Board, subject
to shareowner ratification, the selection of the Company's independent
accountants. During 1995, the Committee consisted of five members of the
Board who are neither officers nor employees of the Company. It meets
regularly with representatives of management, internal audit and the
independent accountants to review internal accounting controls and accounting,
auditing and financial reporting matters. During 1995, the Committee held
five meetings. The Company's internal auditors and independent accountants
periodically meet alone with the Committee to discuss the matters previously
noted and have direct access to it for private communication at any time.
32
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareowner of Pacific Bell:
We have audited the consolidated financial statements and the financial
statement schedule of Pacific Bell (a wholly owned subsidiary of Pacific
Telesis Group) and Subsidiaries (the "Company") as listed in Item 14(a) of
this Form 10-K. These financial statements and the financial statement
schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and the
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Pacific Bell and
Subsidiaries as of December 31, 1995 and 1994 and the consolidated results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1995 in conformity with generally accepted
accounting principles. In addition, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.
As discussed in Note A to the Consolidated Financial Statements, the Company
discontinued application of Statement of Financial Accounting Standards No. 71
during 1995, and adopted new accounting rules for postretirement and
postemployment benefits in 1993.
/s/ Coopers & Lybrand L.L.P.
San Francisco, California
February 22, 1996
33
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the Year Ended December 31
------------------------------
(Dollars in millions) 1995 1994* 1993*
- ---------------------------------------------------------------------------
OPERATING REVENUES
Local service................................ $ 3,742 $3,385 $ 3,411
Network access - interstate.................. 1,682 1,561 1,572
Network access - intrastate.................. 707 731 679
Toll service................................. 1,210 1,984 2,035
Other service revenues....................... 1,521 1,406 1,358
------------------------------
TOTAL OPERATING REVENUES..................... 8,862 9,067 9,055
- ---------------------------------------------------------------------------
OPERATING EXPENSES
Cost of products and services................ 1,810 1,898 1,945
Customer operations and selling expenses..... 1,826 1,846 1,796
General, administrative, and other expenses.. 1,288 1,254 1,459
Property and other taxes..................... 184 183 181
Restructuring charges........................ - - 1,567
Depreciation and amortization................ 1,831 1,758 1,703
------------------------------
TOTAL OPERATING EXPENSES..................... 6,939 6,939 8,651
- ---------------------------------------------------------------------------
OPERATING INCOME............................. 1,923 2,128 404
Interest expense............................. 410 439 429
Miscellaneous income (expense)............... 25 3 (29)
- ---------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES............ 1,538 1,692 (54)
Income tax expense (benefit)................. 569 621 (72)
- ---------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF
ACCOUNTING CHANGES AND EXTRAORDINARY ITEM.. 969 1,071 18
Cumulative effect of accounting change,
net of tax (Note A)........................ - - (148)
Extraordinary item, net of tax (Note B)...... (3,360) - -
------------------------------
NET INCOME (LOSS)............................ $(2,391) $1,071 $ (130)
===========================================================================
* Restated to conform to current year presentation.
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
34
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31
-----------------------
(Dollars in millions) 1995 1994*
- ---------------------------------------------------------------------------
ASSETS
Cash and cash equivalents.......................... $ 68 $ 62
Accounts receivable - net of allowances
for uncollectibles of $131 and $132.............. 1,475 1,531
Prepaid expenses and other current assets.......... 802 950
------------------------
Total current assets............................... 2,345 2,543
------------------------
Property, plant, and equipment..................... 26,688 26,107
Less: accumulated depreciation.................... 15,608 10,243
------------------------
Property, plant, and equipment - net............... 11,080 15,864
------------------------
Deferred charges and other noncurrent assets....... 474 963
------------------------
TOTAL ASSETS....................................... $13,899 $19,370
===========================================================================
LIABILITIES AND SHAREOWNER'S EQUITY
Accounts payable and accrued liabilities........... $ 2,109 $ 1,993
Debt maturing within one year...................... 781 255
Other current liabilities.......................... 552 953
------------------------
Total current liabilities.......................... 3,442 3,201
------------------------
Long-term obligations.............................. 4,608 4,752
------------------------
Deferred income taxes.............................. 321 2,315
------------------------
Other noncurrent liabilities and deferred credits.. 2,417 2,878
------------------------
Commitments and contingencies (Note K)
Common stock ($1.00 stated value; 300,000,000 shares
authorized; 224,504,982 shares issued and
outstanding)..................................... 225 225
Additional paid-in capital......................... 5,387 5,169
Reinvested earnings (deficit)......................
(2,501) 830
------------------------
Total shareowner's equity.......................... 3,111 6,224
------------------------
TOTAL LIABILITIES AND SHAREOWNER'S EQUITY.......... $13,899 $19,370
===========================================================================
* Restated to conform to current year presentation.
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
35
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREOWNER'S EQUITY
For the Year Ended December 31
------------------------------
(Dollars in millions) 1995 1994 1993
- ---------------------------------------------------------------------------
COMMON STOCK
Balance at beginning of year................ $ 225 $ 225 $ 225
------------------------------
Balance at end of year...................... 225 225 225
- ---------------------------------------------------------------------------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year................ 5,169 5,168 5,168
Equity investment by parent................. 218 1 -
------------------------------
Balance at end of year...................... 5,387 5,169 5,168
- ---------------------------------------------------------------------------
REINVESTED EARNINGS (DEFICIT)
Balance at beginning of year................ 830 761 1,898
Net income (loss)........................... (2,391) 1,071 (130)
Dividends declared.......................... (943) (998) (1,007)
Other changes............................... 3 (4) -
------------------------------
Balance at end of year...................... (2,501) 830 761
- ---------------------------------------------------------------------------
TOTAL SHAREOWNER'S EQUITY................... $3,111 $6,224 $6,154
===========================================================================
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
36
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Year Ended December 31
------------------------------
(Dollars in millions) 1995 1994* 1993*
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) OPERATING ACTIVITIES
Net income (loss)................................ $(2,391) $1,071 $(130)
Adjustments to reconcile net income (loss)
to cash from operating activities:
Cumulative effect of accounting change...... - - 148
Restructuring charges....................... - - 1,567
Extraordinary item.......................... 3,360 - -
Depreciation and amortization............... 1,831 1,758 1,703
Deferred income taxes....................... 121 1 (525)
Unamortized investment tax credits.......... (52) (63) (48)
Allowance for funds used during construction (36) (28) (34)
Changes in operating assets and liabilities:
Accounts receivable...................... 55 (12) (71)
Prepaid expenses and other
current assets........................ (29) (13) 16
Deferred charges and other
noncurrent assets..................... (25) (25) 76
Accounts payable and accrued
liabilities........................... 149 170 75
Other current liabilities................ (16) 40 (18)
Noncurrent liabilities and
deferred credits...................... (367) (7) (19)
Other adjustments, net...................... 61 10 31
-------------------------
Cash from operating activities................... 2,661 2,902 2,771
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) INVESTING ACTIVITIES
Additions to property, plant, and equipment...... (1,964) (1,612) (1,802)
Other investing activities, net.................. 19 2 (11)
-------------------------
Cash used for investing activities............... (1,945) (1,610) (1,813)
- ---------------------------------------------------------------------------
* Restated to conform to current year presentation.
(Continued next page)
37
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
For the Year Ended December 31
------------------------------
(Dollars in millions) 1995 1994 1993
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) FINANCING ACTIVITIES
Equity infusion from parent.................. 218 1 -
Proceeds from issuance of long-term debt..... - - 2,578
Retirements of long-term debt................ (514) (11) (2,669)
Dividends paid............................... (943) (998) (1,007)
Increase (decrease) in short-term
borrowings, net............................ 526 (287) 133
Other financing activities, net.............. 3 8 7
-----------------------------
Cash used for financing activities........... (710) (1,287) (958)
- ---------------------------------------------------------------------------
Increase in cash and
cash equivalents........................... 6 5 -
Cash and cash equivalents at January 1....... 62 57 57
-----------------------------
Cash and cash equivalents at December 31..... $ 68 $ 62 $ 57
===========================================================================
* Restated to conform to current year presentation.
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
38
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The Consolidated Financial Statements include the accounts of Pacific Bell and
its wholly owned subsidiaries: Pacific Bell Directory, Pacific Bell
Information Services, Pacific Bell Mobile Services, Pacific Bell Internet
Services, Pacific Bell Network Integration, and others ("the Company"). The
Company is a wholly owned subsidiary of Pacific Telesis Group. All
significant intercompany balances and transactions have been eliminated. The
Consolidated Balance Sheets for 1994 as well as the Consolidated Statements of
Income and Consolidated Statements of Cash Flows for 1994 and 1993 reflect
certain reclassifications made to conform to the current year presentation.
The Company's investment in Bellcore is accounted for under the equity method.
The Company's principal business, communications and information services,
accounts for substantially all of its revenues. The Company provides local
exchange services, network access, local toll services, directory advertising,
Internet access, and selected information services in California.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
Regulatory Accounting
Effective third quarter 1995, the Company discontinued accounting under
Statement of Financial Accounting Standards No. ("SFAS") 71, "Accounting
for the Effects of Certain Types of Regulation." (See Note B -
"Discontinuance of Regulatory Accounting - SFAS 71" on page 41.)
Property, Plant, and Equipment
Property, Plant, and Equipment (which consists primarily of telecommunications
plant dedicated to providing telecommunications services) is carried at cost.
The cost of self-constructed plant includes employee wages and benefits,
materials, capitalized interest during the construction period, and other
costs. Expenditures in excess of $500 that increase the capacity, operating
efficiency, or useful life of an individual asset are capitalized.
Expenditures for maintenance and repairs are charged to expense.
39
<PAGE>
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
No gain or loss is recognized on the disposition of depreciable
telecommunications plant. At the time of retirement of telecommunication
property, plant, and equipment, the original cost of the plant retired plus
cost of removal is charged to accumulated depreciation. Accumulated
depreciation is credited with salvage value or insurance recovery, if any.
Depreciation expense is computed by straight line depreciation based on
management's estimate of economic lives for various categories of property,
plant, and equipment.
The Company continues to invest heavily in improvements to its core telephone
network. These technologies are subject to technological risks and rapid
market changes due to new products and services and changing customer demand.
This may result in changes to the estimated useful lives of these assets.
The Company carries catastrophic insurance coverage with large deductibles on
its telecommunications switching and building assets, and is self-insured for
its outside plant telecommunications assets.
Cash and Cash Equivalents
Cash equivalents include all highly liquid monetary instruments with
maturities of ninety days or less from the date of purchase. In its cash
management practices, the Company maintains zero-balance disbursement accounts
for which funds are made available as checks are presented for clearance.
Checks outstanding are included in accounts payable.
Income Taxes
Pacific Telesis Group allocates consolidated taxes as if the Company were a
separate taxpayer. The Company records its share of the consolidated taxes as
tax liabilities and pays amounts due to tax authorities through Pacific
Telesis Group.
Deferred income taxes are provided to reflect the tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for tax purposes.
Investment tax credits earned prior to their repeal by the Tax Reform Act of
1986 are amortized as reductions in tax expense over the lives of the assets
which gave rise to the credits.
Advertising Costs
Costs for advertising products and services or corporate image are expensed as
incurred.
40
<PAGE>
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
Computer Software Costs
The costs of computer software purchased or developed for internal use are
expensed as incurred. However, initial operating system software costs are
capitalized and amortized over the lives of the associated hardware. Costs
for subsequent additions or modifications to operating system software are
expensed as incurred.
Change in Accounting for Postretirement and Postemployment Costs
Effective January 1, 1993, the Company adopted SFAS 106, "Employers'
Accounting for Postretirement Benefits Other than Pensions." Annual price cap
decisions by the CPUC granted the Company approximately $100 million for each
of the years 1993-1996 for partial recovery of its higher costs. However, a
CPUC order held that revenues collected after October 12, 1994 are subject to
refund. (See "Revenues Subject to Refund" in Note K on page 54.)
Effective January 1, 1993, the Company adopted SFAS 112, "Employers'
Accounting for Postemployment Benefits." A one-time, non-cash charge
representing prior benefits earned was recorded in 1993 which reduced earnings
by $148 million. The charge was net of a deferred income tax benefit of
$103 million. The annual periodic expense under SFAS 112 does not differ
materially from expense under the prior method. (See also Note F - "Other
Postretirement and Postemployment Benefits" on page 49.)
B. DISCONTINUANCE OF REGULATORY ACCOUNTING - SFAS 71
Effective third quarter 1995, the Company discontinued its application of
SFAS 71 in accordance with the provisions of SFAS 101, "Accounting for the
Discontinuance of Application of FASB Statement No. 71." As a result, the
Company recorded a non-cash, extraordinary charge of $3.4 billion during third
quarter which is net of a deferred income tax benefit of $2.4 billion.
The charge includes a write-down of net telephone plant and the elimination
of net regulatory assets as summarized in the following table.
(Dollars in millions) Pre-Tax After-Tax
------------------------------------------------------------------------
Increase in telephone plant and equipment
accumulated depreciation............... $4,819 $2,842
Elimination of net regulatory assets..... 962 518
------ ------
Total.................................... $5,781 $3,360
========================================================================
The Company historically accounted for the economic effects of regulation
in accordance with the provisions of SFAS 71. Under SFAS 71, the Company
depreciated telephone plant using lives prescribed by regulators and, as
a result of actions of regulators, deferred recognizing certain costs, or
recognized certain liabilities (referred to as "regulatory assets" and
"regulatory liabilities").
41
<PAGE>
B. DISCONTINUANCE OF REGULATORY ACCOUNTING - SFAS 71 (Cont'd)
Effective third quarter 1995, management determined that, for external
financial reporting purposes, it is no longer appropriate for the Company to
use the special SFAS 71 accounting rules for entities subject to traditional
regulation. Management's decision to change to the general accounting rules
used by competitive enterprises was based upon an assessment of the emerging
competitive environment in California. Prices for the Company's products and
services are being driven increasingly by market forces instead of regulation.
The $4.8 billion increase in accumulated depreciation for telephone plant
reflects the adoption of new, shorter depreciation lives. The estimated
useful lives historically prescribed by regulators did not keep up with the
rapid pace of technology. The Company's previous and new asset lives are
compared in the following table.
Asset Lives (in years) Old New
- -------------------------------------------------------------------------
Copper Cable.............................. 19-26 14
Digital Switches.......................... 16.5 10
Digital Circuits.......................... 9.6-11.5 8
Fiber Optic Cable......................... 28-30 20
Conduit................................... 59 50
=========================================================================
The discontinuance of SFAS 71 for external financial reporting purposes also
required the elimination of the Company's net regulatory assets, totaling
$962 million. Regulators sometimes include costs in allowable costs for
ratemaking purposes in a period other than the period in which those costs
would be charged to expense under general accounting rules. The accounting for
these timing differences created regulatory assets and regulatory liabilities
on the balance sheet.
Significant changes have occurred in the Company's balance sheets as a result
of the discontinuance of SFAS 71. Details of net regulatory assets which
have been eliminated are displayed in the following table.
(Dollars in millions)
- --------------------------------------------------------------------------
Regulatory assets (liabilities) due to:
Deferred pension costs*.............................. $460
Unamortized debt redemption costs**.................. 337
Deferred compensated absence costs*.................. 206
Unamortized purchases of property, plant,
and equipment under $500............................. 82
Deferred income taxes***............................... (159)
Other................................................... 36
-----
Total................................................... $962
==========================================================================
* Previously included primarily in "deferred charges and other noncurrent
assets" in the balance sheets.
** Previously included in "long-term obligations."
*** Previously included in "other current liabilities" and "other noncurrent
liabilities and deferred credits."
42
<PAGE>
B. DISCONTINUANCE OF REGULATORY ACCOUNTING - SFAS 71 (Cont'd)
Due to the discontinued application of SFAS 71, pension costs for both
intrastate and interstate operations are now determined under SFAS 87,
"Employers' Accounting for Pensions", and SFAS 88, "Employers' Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits." Capitalized interest cost is reported as a cost of
telephone plant and equipment and as a reduction in interest expense, as
required by SFAS 34, "Capitalization of Interest Cost." Prior to the
discontinuance of SFAS 71, the Company recorded an allowance for funds used
during construction, which included both interest and equity return
components, as a cost of plant and as an item of miscellaneous income. The
Company's accounting and reporting for regulatory purposes are not affected by
the discontinued application of SFAS 71 for external financial reporting
purposes.
C. RESTRUCTURING AND CURTAILMENT CHARGES
During 1993, the Company recorded a pre-tax restructuring charge of $977
million to recognize the incremental cost of force reductions associated with
restructuring its internal business processes through 1997. This charge is to
cover the incremental severance costs associated with terminating more than
14,000 employees from 1994 through 1997. It is also to cover the incremental
costs of consolidating and streamlining operations and facilities to support
this downsizing initiative. The remaining reserve balance as of December 31,
1995 and 1994 was $219 and $819 million, respectively.
In addition, the Company recorded a $590 million pre-tax expense to accelerate
recognition of a portion of its embedded post-retirement benefits costs that
would otherwise have been recorded over the next 19 years. Accelerated
recognition of these costs was required under the curtailment provisions of
SFAS 106 because the Company expects to significantly reduce its workforce.
Because Pacific Telesis Group already recognized all of its post-retirement
benefit transition costs in the first quarter 1993, this additional charge did
not affect its consolidated financial statements.
43
<PAGE>
D. INCOME TAXES
The components of income tax expense for each year are as follows:
Income Tax Expense 1995 1994* 1993*
- ---------------------------------------------------------------------------
(Dollars in millions)
Current:
Federal.................................. $406 $549 $519
State and local income taxes............. 122 166 156
-----------------------------
Total current.............................. 528 715 675
Deferred:
Federal.................................. 66 (24) (548)
State and local income taxes............. 27 (7) (148)
----------------------------
Total deferred............................. 93 (31) (696)
----------------------------
Amortization of investment
tax credits - net.......................... (52) (63) (51)
----------------------------
Total income tax expense (benefit)......... $569 $621 $(72)
===========================================================================
Significant components of the Company's deferred tax assets and liabilities
are as follows:
December 31
-------------------
Deferred Tax Assets and Liabilities 1995 1994*
- ---------------------------------------------------------------------------
(Dollars in millions)
Deferred tax (assets)/liabilities due to:
Depreciation and amortization.................... $ 891 $2,885
Employee benefits................................ (431) (371)
Restructuring reserve............................ (124) (359)
Customer rate reductions......................... (128) (146)
Other, net....................................... (446) (74)
------ -------
Net deferred tax (assets)/liabilities.............. $(238) $1,935
====== =======
Amounts recorded in consolidated
balance sheets:
Deferred tax assets**............................ $ 559 $ 380
====== =======
Deferred tax liabilities**....................... $ 321 $2,315
====== =======
===========================================================================
* Restated to conform to current year presentation.
** Reflects reclassification of certain current and noncurrent amounts by
federal and state tax jurisdictions to a net presentation. Amounts
include both current and noncurrent portions. (See Note M "Additional
Financial Information" on page 56 for current deferred tax benefits.)
44
<PAGE>
D. INCOME TAXES (Cont'd)
An income tax benefit related to the extraordinary charge in 1995 for the
discontinued application of SFAS 71 for depreciated telecommunications plant
is $2.0 billion and for regulatory assets and liabilities is $0.4 billion.
(See Note B - "Discontinuance of Regulatory Accounting - SFAS 71 on page 41.)
The reasons for differences each year between the effective income tax rate
and applying the statutory federal income tax rate to income before income
taxes are provided in the following reconciliation:
Effective Tax Rate 1995 1994 1993
- ----------------------------------------------------------------------------
Statutory federal income tax rate (%)........ 35.0 35.0 35.0
Increase (decrease) in taxes resulting from:
Amortization of investment tax credits..... (3.4) (3.6) 92.9
Plant basis differences - net of
applicable depreciation................. 2.1 2.0 (63.6)
State income taxes - net of federal
income tax benefit...................... 6.2 6.1 (9.2)
Excess deferred taxes...................... (2.9) (2.8) 70.1
Other differences.......................... - - 7.2
----------------------------
Effective income tax rate (%)................ 37.0 36.7 132.4
============================================================================
The 1993 effective tax rate was higher than in subsequent years due to lower
pre-tax income caused by the restructuring charge and the postretirement
benefits curtailment.
E. EMPLOYEE RETIREMENT PLANS
Defined Benefit Plans
The Company provides pension, death, and survivor benefits to substantially
all of its employees through participation in certain Pacific Telesis Group
defined benefit pension plans. Non-salaried plan benefits are based on a flat
dollar amount and vary according to job classification, age, and years of
service. Salaried plan benefits are based on a percentage of final five-year
average pay and vary according to age and years of service.
The Company is responsible for contributing enough to the pension plans, while
the employee still is working, to ensure that adequate funds are available to
provide the benefit payments upon the employee's retirement. These
contributions are made to an irrevocable trust fund in amounts determined
using the aggregate cost actuarial method, one of the actuarial methods
specified by the Employee Retirement Income Security Act of 1974 ("ERISA"),
subject to ERISA and Internal Revenue Code limitations.
45
<PAGE>
E. EMPLOYEE RETIREMENT PLANS (Cont'd)
The Company reports pension costs and related obligations under the provisions
of SFAS 87 and SFAS 88. However, prior to discontinuing application of SFAS
71 during 1995, the Company recognized pension costs consistent with the
methods adopted for ratemaking. Pension costs recognized under SFAS 71
reflected a CPUC order requiring the continued use of the aggregate cost
method for intrastate operations and an FCC requirement to use SFAS 87 and
SFAS 88 for interstate operations. (See Note B - "Discontinuance of
Regulatory Accounting - SFAS 71" on page 41).
During 1995 and 1994, special pension benefits and cash incentives were
offered in connection with the Company's restructuring and related force
reduction program. Effective October 1, 1995, pension benefit increases are
being offered to various groups of non-salaried employees under 1995 plan
amendments which increase benefits for specified groups who elect early
retirement under incentive programs. On March 28, 1994, the Company offered a
special pension benefit which removed any age discount from pensions for
management employees who were eligible to retire with a service pension on
that date. Also during 1994, pension benefit increases were offered to
various groups of non-salaried employees under 1992 plan amendments which
increase benefits for specified groups who elect early retirement under
incentive programs. Approximately 1,900 and 3,400 employees left the Company
during 1995 and 1994, respectively, under early retirement or voluntary and
involuntary severance programs.
Annual pension cost in the following table excludes $219 and $62 million of
additional pension costs charged to the Company's restructuring reserve in
1995 and 1994, respectively. As required by regulatory accounting under SFAS
71, pension cost in the table below also excludes the intrastate portion of
the Company's SFAS 87 costs of $79 and $53 million for 1994 and 1993
respectively. As discussed above, the Company discontinued the application of
SFAS 71 during 1995. (See Note B - "Discontinuance of Regulatory Accounting -
SFAS 71" on page 41).
46
<PAGE>
E. EMPLOYEE RETIREMENT PLANS (Cont'd)
Annual pension cost recognized in the financial statements during each year
presented is:
Pension Cost 1995 1994 1993
- --------------------------------------------------------------------------
(Dollars in millions)
Current year pension cost................... $ 76 $ 28 $ 10
Settlements and curtailments................ - (10) (10)
-----------------------------
Pension cost recognized..................... $ 76 $ 18 $ 0
==========================================================================
The amounts shown above for annual pension cost reflect the effects of strong
fund asset performance in prior years and IRS funding limitations.
December 31
--------------------------
Pension Obligation 1995 1994
- --------------------------------------------------------------------------
(Dollars in millions)
Accumulated Benefit Obligation................. $8,835 $8,008
Vested Benefit Obligation...................... $7,747 $7,174
- --------------------------------------------------------------------------
Accrued pension cost liability recognized in
the consolidated balance sheets.............. $1,061 $ 753
- --------------------------------------------------------------------------
Present value discount rate (%)................ 7.25 8.0
Long-term rate of return on plan assets (%).... 9.0 8.0
==========================================================================
Liabilities and expenses for employee benefits are based on actuarial
assumptions. These actuarial assumptions are subject to change over time
which could have a material impact on the Company's financial statements.
47
<PAGE>
E. EMPLOYEE RETIREMENT PLANS (Cont'd)
The assets of the plans are primarily composed of common stocks, U.S.
Government and corporate obligations, index funds, and real estate
investments. The plans' projected benefit obligations for employee service to
date reflect the Company's expectations of the effects of future salary
progression and benefit increases.
Effective December 31, 1993, the salaried pension plan was amended to
permanently remove the age discount from pension benefits for employees with
30 or more years of net credited service. Effective January 1, 1995, the
salaried pension plan was also amended to cap net credited service for pension
benefits at 30 years or, if greater, the amount of the employee's service on
January 1, 1995. Upon adoption, these amendments affected approximately 400
and 800 employees, respectively.
The Company has entered into labor negotiations with union-represented
employees in the past and expects to do so in the future. Pension benefits
have been included in these negotiations, and improvements in benefits have
been made periodically. Additionally, the Company has increased benefits to
pensioners on an ad hoc basis. While no assurance can be offered with respect
to future increases, management's expectations for future benefit increases
have been reflected in determining pension costs.
Defined Contribution Plans
The Company also participates in certain Pacific Telesis Group-sponsored
defined contribution retirement plans covering substantially all employees.
These plans include the Pacific Telesis Group Supplemental Retirement and
Savings Plan for Salaried Employees, and the Pacific Telesis Group
Supplemental Retirement and Savings Plan for Nonsalaried Employees
(collectively, the "Savings Plans").
The Company's contributions to the Savings Plans are based on matching a
portion of employee contributions. All matching employer contributions to the
Savings Plans are made through a leveraged employee stock ownership ("LESOP")
trust. Total Company contributions to these plans, including contributions
allocated to participant accounts through the LESOP trust, were $68, $64, and
$64 million in 1995, 1994, and 1993, respectively.
48
<PAGE>
F. OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
Substantially all retirees and their dependents are covered under the
Company's plans for medical, dental and life insurance benefits.
Approximately 41,000 retirees were eligible to receive these benefits as of
January 1, 1995. Currently, the Company pays the full cost of retiree health
benefits. However, by 1999, all employees retiring after 1990 will pay a share
of the costs of medical coverage that exceeds a defined dollar medical cap.
Such future cost sharing provisions have been reflected in determining the
Company's postretirement benefit costs. The Company retains the right,
subject to applicable legal requirements, to amend or terminate these
benefits.
Effective January 1, 1993, the Company adopted SFAS 106. The standard
requires that the cost of retiree benefits be recognized in the financial
statements from an employee's date of hire until the employee becomes eligible
for these benefits. Previously, the Company expensed these retiree benefits
as they were paid. The Company is amortizing the transition obligation over
20 years from the date of adoption. The transition obligation represents the
unrecognized cost of benefits that had already been earned by retirees and
active employees when the new standard was adopted.
The Company's periodic expense under SFAS 106 in 1995 and 1994, as displayed
in the table below, increased from a level of $103 million in costs in 1992
under the prior method. Because the Company's higher costs are being partially
recovered in revenues, the increased costs have not materially affected
reported earnings. (See "Change in Accounting for Postretirement and
Postemployment Costs" in Note A on page 39.) However, a CPUC order held that
related revenues collected after October 12, 1994 are subject to refund. (See
"Revenues Subject to Refund" in Note K on page 54.)
The components of net periodic postretirement benefit cost are as follows:
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
Service cost.................................. $ 49 $ 57
Interest cost on accumulated postretirement
benefit obligation.......................... 256 251
Actual return on plan assets.................. (246) (17)
Net amortization and deferral................. 268 45
----- -----
Net periodic postretirement benefit cost...... $327 $336
=========================================================================
49
<PAGE>
F. OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (Cont'd)
The Company partially funds the obligation by contributing to Voluntary
Employee Benefit Association trusts. Plan assets are invested primarily in
domestic and international stocks and domestic investment-grade bonds.
The funded status of the plans follows:
December 31
--------------------
(Dollars in millions) 1995 1994
- ----------------------------------------------------------------------------
Accumulated postretirement benefit obligation:
Retirees.................................... $2,250 $2,250
Eligible active employees................... 216 264
Other active employees...................... 769 784
------ ------
Total accumulated postretirement benefit
obligation.................................. 3,235 3,298
Less:
Fair value of plan assets*.................. (1,217) (860)
Transition obligation....................... (1,609) (1,704)
Plus:
Unrecognized net gain/(loss)**.............. 164 (157)
Unrecognized prior service cost............. 38 -
------ ------
Accrued net postretirement benefit obligation
recognized in the consolidated
balance sheets............................. $ 611 $ 577
============================================================================
* Fair value of plan assets reflects an estimated allocation of the
Company's portion of Pacific Telesis Group plans' assets.
** The unrecognized net gain/(loss) is amortized over the future expected
service lives of approximately 16 years and reflects differences between
actuarial assumptions and actual experience. It also includes the impact
of changes in actuarial assumptions.
50
<PAGE>
F. OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (Cont'd)
Liabilities and expenses for employee benefits are based on actuarial
assumptions. The assumed discount rate used to measure the year-end
accumulated postretirement benefit obligation was 7.25 percent and 8.0 percent
for 1995 and 1994, respectively. The 1995 accumulated postretirement benefit
obligation and the 1996 expense are based on an assumed annual increase in
health care costs of 6.0 percent. Increasing the assumed health care cost
trend rates by one percent each year, would increase the December 31, 1995
accumulated postretirement benefit obligation by $415 million and increase the
combined service and interest cost components of net periodic postretirement
benefit cost for 1995 by $39 million. An 8.75 percent long-term rate-of-return
on assets is assumed in calculating postretirement benefit costs. Based on
the plans' historical return on assets, the assumed long-term rate of return
will be increased to 9.0 percent in 1996. These actuarial assumptions are
subject to change over time, which could have a material impact on the
Company's financial statements.
Effective January 1, 1993, the Company adopted SFAS 112 for accounting for
postemployment benefits which required a change from cash to accrual
accounting. Postemployment benefits offered by the Company include workers
compensation, disability benefits, medical benefit continuation, and severance
pay. These benefits are paid to former or inactive employees who terminate
without retiring. A one-time, non-cash charge representing prior benefits
earned was recorded in 1993 which reduced earnings by $148 million. The charge
was net of a deferred income tax benefit of $103 million. The annual periodic
expense under SFAS 112 does not differ materially from expense under the prior
method.
G. DEBT AND LEASE OBLIGATIONS
Long-term obligations as of December 31, 1995 and 1994 consist of debentures
of $3,545 and $4,047 million, respectively, and corporate notes of $1,150
million each year. Maturities and interest rates of long-term obligations
follow:
51
<PAGE>
G. DEBT AND LEASE OBLIGATIONS (Cont'd)
December 31
------------------------
Maturities and Interest Rates 1995 1994
- --------------------------------------------------------------------------
(Dollars in millions)
1999 4.625%.................... $ 100 $ 100
2000 4.625%.................... 125 125
2001-2043 6.000% to 9.125%.......... 4,470 4,972
-----------------------
4,695 5,197
Long-term capital lease obligations............. 18 16
Unamortized discount-net of premium............. (105) (461)
-----------------------
Total long-term obligations..................... $4,608 $4,752
==========================================================================
At December 31, 1995, the Company had remaining authority from the CPUC to
issue up to $1.25 billion of long- and intermediate-term debt. The proceeds
may be used only to redeem maturing debt and to refinance other debt issues.
The Company had remaining authority from the Securities and Exchange
Commission to issue up to $650 million of long- and intermediate-term debt
through a shelf registration. In February 1996, the Company issued $250
million of intermediate-term debt under these authorities. (See Note J -
Subsequent Event on page 54.)
As of December 31, 1995 and 1994, the weighted average interest rate on short-
term borrowings was 5.82 percent and 6.05 percent, respectively. Debt
maturing within one year in the balance sheets consists of short-term
borrowings and the portion of long-term obligations that matures within one
year as follows:
December 31
-------------------------
(Dollars in millions) 1995 1994
- --------------------------------------------------------------------------
Commercial paper.......................... $701 $ -
Advances from Pacific Telesis Group....... 76 249
Notes payable to banks.................... - 2
-------------------------
Total short-term borrowings............... 777 251
-------------------------
Current maturities of
long-term obligations..................... 4 4
-------------------------
Total debt maturing within one year....... $781 $255
==========================================================================
52
<PAGE>
G. DEBT AND LEASE OBLIGATIONS (Cont'd)
Lines of Credit
The Company has various uncommitted lines of credit with certain banks. These
arrangements do not require compensating balances or commitment fees and,
accordingly, are subject to continued review by the lending institutions. As
of December 31, 1995 and 1994, the total unused lines of credit available were
approximately $2.7 and $2.2 billion, respectively.
H. FINANCIAL INSTRUMENTS
The following table presents the estimated fair values of the Company's
financial instruments:
December 31, 1995 December 31, 1994
----------------- -----------------
Estimated Estimated
Carry Fair Carrying Fair
(Dollars in millions) Amount Value Amount* Value
- ----------------------------------------------------------------------------
Cash and cash equivalents........ $ 68 $ 68 $ 62 $ 62
Debt maturing within one year.... 781 781 255 255
Deposit liabilities.............. 357 357 305 305
Long-term debt................... $4,590 $4,881 $4,736 $4,578
============================================================================
* Restated to conform to current year presentation.
The following methods and assumptions were used to estimate the fair values of
each category of financial instrument:
The fair values of cash and cash equivalents, debt maturing within one year,
and deposit liabilities approximate their carrying amounts because of the
short-term maturities of these instruments.
The fair value of long-term debt issues was estimated based on the net present
value of future expected cash flows, which were discounted using current
interest rates. The carrying amounts include unamortized net discount.
53
<PAGE>
I. RELATED PARTY TRANSACTIONS
The Company receives certain services associated with corporate functions,
e.g., legal, financial, external affairs and governmental relations, human
resources and corporate strategy, performed on the Company's behalf by its
parent, Pacific Telesis Group. Costs incurred by Pacific Telesis Group which
are attributable to the Company are charged directly to the Company. The
Company is also charged for its proportionate share of other indirect costs
incurred by Pacific Telesis Group. Total costs charged by Pacific Telesis
Group and included in general, administrative, and other expenses were $110
million, $81 million and $76 million in 1995, 1994 and 1993, respectively.
The Company provides non-telecommunications and telecommunications services
including local, toll and access services to certain Pacific Telesis Group
affiliated companies. Revenues recorded for these services totaled $7 million,
$21 million and $30 million in 1995, 1994 and 1993, respectively.
J. SUBSEQUENT EVENT
In February 1996, the Company issued $250 million of 5.875 percent debentures
due February 15, 2006. The debentures may not be redeemed prior to maturity.
The proceeds from the sale of the debentures were used to reduce short-term
debt incurred to retire debentures totaling $500 million in December 1995.
K. COMMITMENTS AND CONTINGENCIES
Purchase Commitments
In December 1994, the Company contracted for the purchase of up to $2 billion
of Advanced Communications Network facilities which will incorporate emerging
technologies. The Company is committed to purchase these facilities in 1998
if they meet certain quality and performance criteria. Management expects the
purchase amount to be less than $1 billion in 1998.
The Company has purchase commitments of about $274 million remaining in
connection with its previously announced program for deploying an all digital
switching platform with ISDN and SS-7 capabilities.
Revenues Subject to Refund
In 1992, the CPUC issued a decision adopting, with modification, SFAS 106 for
regulatory accounting purposes. Annual price cap decisions by the CPUC
granted the Company approximately $100 million in each of the years 1993-1996
for partial recovery of higher costs under SFAS 106. However, the CPUC in
October 1994 reopened the proceeding to determine the criteria for exogenous
cost treatment and whether the Company should continue to recover these costs.
The CPUC's order held that related revenues collected after October 12, 1994
are subject to refund plus interest. Related revenues totaled about $122
million at December 31, 1995. Management believes postretirement benefits
costs are appropriately recoverable in the Company's price cap filings. It is
possible that the CPUC could decide this issue in the near term, and that the
decision could have a material adverse effect on financial results.
54
<PAGE>
K. COMMITMENTS AND CONTINGENCIES (Cont'd)
Property Tax Investigation
In 1992, a settlement agreement was reached between the State Board of
Equalization, all California counties, the State Attorney General, and 28
utilities, including Pacific Bell, on a specific methodology for valuing
utility property for property tax purposes. The CPUC opened an investigation
to determine if any resulting property tax savings should be returned to
customers. Intervenors have asserted that as much as $20 million of annual
property tax savings should be treated as an exogenous cost reduction in the
Company's annual price cap filings. These intervenors have also asserted that
past property tax savings totaling as much as $60 million plus interest should
be returned to customers. Management believes that, under the CPUC's
regulatory framework, any property tax savings should be treated only as a
component of the calculation of shareable earnings. In an Interim Opinion
issued in June 1995, the CPUC decided to defer a final decision on this matter
pending resolution of the criteria for exogenous cost treatment under its
regulatory framework. The criteria are being considered in a separate
proceeding initiated for rehearing of the CPUC's postretirement benefits other
than pensions decision discussed above. It is possible that the CPUC could
decide this issue in the near term, and that the decision could have a
material adverse effect on financial results.
L. COMPETITIVE RISK
The Company is facing increasing competition for existing and new services.
Currently, competitors primarily consist of interexchange carriers,
competitive access providers and wireless companies. Soon the Company will
face competition from cable television companies and others.
In 1995 the CPUC authorized toll services competition and also ordered the
Company to offer expanded interconnection to competitive access providers.
Effective January 1, 1996, the CPUC authorized local exchange competition.
Local exchange competition may affect toll and access revenues, as well as
local exchange revenues, since customers may select a competitor for all their
telecommunications services. Local exchange competition may also affect other
service revenues as Pacific Bell Directory will have to acquire listings from
other providers for its products, and competing directory publishers may ally
themselves with other telecommunications providers.
The unique characteristics of the California market make the Company
vulnerable to competition. The Company's business and residence revenues and
profitability are highly concentrated among a small portion of its customer
base and geographic areas. Competitors need only serve selected portions of
the Company's service area to compete for the majority of its business and
residence usage revenues. High-margin customers are clustered in high density
areas such as Los Angeles and Orange County, the San Francisco Bay Area, San
Diego and Sacramento. Competitors are expected to target the high-usage, high-
profit customers.
55
<PAGE>
M. ADDITIONAL FINANCIAL INFORMATION
December 31
----------------------
(Dollars in millions) 1995 1994*
- ----------------------------------------------------------------------------
Prepaid expenses and other current assets:
Prepaid directory expenses................... $ 316 $ 323
Miscellaneous prepaid expenses............... 27 23
Notes and other receivables.................. 83 63
Materials and supplies....................... 57 60
Current deferred tax benefits................ 221 380
Pacific Telesis Group and subsidiaries....... 23 29
Deferred compensation trusts................. 63 52
Other........................................ 12 20
------- -------
Total............................................. $ 802 $ 950
============================================================================
Property, plant, and equipment - net:
Land and buildings........................... $ 2,754 $ 2,636
Cable and conduit............................ 10,910 10,566
Central office equipment..................... 9,394 9,444
Furniture, equipment, and other.............. 2,835 2,892
Construction in progress..................... 795 569
------- -------
26,688 26,107
Less: accumulated depreciation............... 15,608 10,243
------- -------
Total............................................. $11,080 $15,864
============================================================================
Deferred charges and other noncurrent assets:
Deferred charges............................. $ 30 $ 67
Deferred compensated absence................. - 212
SFAS 87 pension deferral..................... - 430
Investment in Bellcore....................... 27 28
Other investments............................ 78 49
Postretirement benefits prefunding........... - 176
Deferred tax benefits........................ 338 -
Other........................................ 1 1
------- -------
Total............................................. $ 474 $ 963
============================================================================
* Restated to conform to current year presentation.
56
<PAGE>
M. ADDITIONAL FINANCIAL INFORMATION (Cont'd)
December 31
----------------------
(Dollars in millions) 1995 1994*
- ----------------------------------------------------------------------------
Accounts payable and accrued liabilities:
Accounts payable:
Pacific Telesis Group and subsidiaries....... $ 37 $ 52
AT&T and subsidiaries........................ 224 218
Trade........................................ 498 474
Payroll...................................... 51 43
Checks outstanding........................... 276 319
Other:
Incentive awards payable................... 187 224
Other...................................... 383 250
Interest accrued................................ 120 127
Advance billing and customer deposits........... 333 286
------- -------
Total............................................ $ 2,109 $ 1,993
============================================================================
Other current liabilities:
Accrued compensated absence................... $ 272 $ 281
Deferred regulatory liabilities (SFAS 109).... - 145
Restructuring reserve......................... 219 441
Other......................................... 61 86
------- ------
Total............................................. $ 552 $ 953
============================================================================
Other noncurrent liabilities and deferred credits:
Unamortized investment tax credits............ $ 283 $ 464
Accrued pension cost liability................ 1,061 753
Deferred regulatory liabilities (SFAS 109).... - 40
Workers' compensation......................... 163 175
Restructuring reserve......................... - 378
Accrued postretirement benefit obligation..... 611 577
Other......................................... 299 491
------- -------
Total............................................. $ 2,417 $ 2,878
============================================================================
* Restated to conform to current year presentation.
57
<PAGE>
M. ADDITIONAL FINANCIAL INFORMATION (Cont'd)
For the Year Ended
December 31
---------------------------------
(Dollars in millions) 1995 1994* 1993*
- --------------------------------------------------------------------------
Other service revenues:
Directory advertising............... $1,012 $ 984 $ 989
Billing and collections............. 109 77 79
Information services............... 148 113 82
Other............................... 252 232 208
------ ------ ------
Total................................... $1,521 $1,406 $1,358
==========================================================================
Interest expense:
Gross interest expense............. $ 421 $ 439 $ 429
Less: Capitalized interest......... (11) - -
------ ------ ------
Net interest expense................... $ 410 $ 439 $ 429
==========================================================================
Miscellaneous income (expense):
Allowance for funds used during
construction...................... $ 36 $ 28 $ 35
Interest income..................... 27 5 5
Other............................... (38) (30) (69)
------ ------ ------
Total................................... $ 25 $ 3 $ (29)
==========================================================================
Advertising expense..................... $ 93 $ 96 $ 61
============================================================================
Cash payments for:
Interest............................ $ 410 $ 377 $ 614
Income taxes........................ $ 550 $ 762 $ 744
============================================================================
* Restated to conform to current year presentation.
Major Customer
Nearly all of the Company's revenues were from telecommunications and related
services. Approximately 10 percent, 11 percent and 11 percent of operating
revenues were earned in 1995, 1994 and 1993, respectively, for services
provided to AT&T Corp. No other customer accounted for more than 10 percent
of operating revenues.
58
<PAGE>
QUARTERLY FINANCIAL INFORMATION
(Unaudited)
(Dollars in millions)
-------------------------------------------
1995 First Second Third Fourth
- ----------------------------------------------------------------------------
Total Operating Revenues.... $2,212 $2,186 $ 2,228 $2,236
Operating Income............ 470 494 507 452
Extraordinary Item.......... - - (3,360) -
Net Income (Loss)........... $ 246 $ 243 $(3,102) $ 222
- ----------------------------------------------------------------------------
1994* First Second Third Fourth
- ----------------------------------------------------------------------------
Total Operating Revenues.... $2,247 $2,209 $ 2,285 $2,326
Operating Income............ 526 529 580 493
Net Income..................
$ 276 $ 256 $ 292 $ 247
============================================================================
* Restated to conform to current year presentation.
Second quarter 1994 results reflect an after-tax charge of $29 million
resulting from a CPUC order related to customer late payment charges.
Third quarter 1995 results reflect an after-tax extraordinary charge as a
result of the company's discontinuance of regulatory accounting. (See Note B -
"Discontinuance of Regulatory Accounting - SFAS 71" on page 41.)
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
No disagreements with the Company's independent accountants on any accounting
or financial disclosure matters occurred during the period covered by this
report.
59
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Documents filed as part of the report:
(1) Financial Statements:
Report of Management............................... 31
Report of Independent Accountants.................. 33
Financial Statements:
Consolidated Statements of Income............. 34
Consolidated Balance Sheets................... 35
Consolidated Statements of Shareowner's
Equity........................................ 36
Consolidated Statements of Cash Flows......... 37
Notes to Consolidated Financial Statements.... 39
(2) Financial Statement Schedule:
II - Valuation and Qualifying Accounts............. 63
Financial statement schedules other than listed above have been
omitted because the required information is contained in the
Consolidated Financial Statements and Notes thereto, or because
such schedules are not required or applicable.
60
<PAGE>
EXHIBIT INDEX
(3) Exhibits:
Exhibits identified in parentheses below as on file with the SEC are
incorporated herein by reference as exhibits hereto. All other exhibits are
provided as part of the electronic transmission.
Exhibit
Number Description
------- -----------
3a Articles of Incorporation of Pacific Bell, as amended and restated
to January 11, 1993 (Exhibit (3)a to Form SE filed March 26, 1993 in
connection with the Company's Form 10-K for 1992).
3b By-Laws of Pacific Bell, as amended to February 26, 1996.
4 No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Bell and its subsidiaries is filed
herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A).
Pursuant to this regulation, Pacific Bell hereby agrees to furnish a
copy of any such instrument to the SEC upon request.
12 Computation of Ratio of Earnings to Fixed Charges.
23 Consent of Coopers & Lybrand L.L.P.
24 Powers of Attorney executed by Directors and Officers who signed
this Form 10-K.
27 Financial Data Schedule for Pacific Bell Form 10-K.
The Corporation will furnish to a security holder upon request a copy of any
exhibit at cost.
(b) Reports on Form 8-K:
Form 8-K, Date of Report November 17, 1995, was filed with the SEC under
Item 5 describing a class action complaint.
61
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
PACIFIC BELL
BY /s/ Peter A. Darbee
-------------------------
Peter A. Darbee,
Vice President, Chief
Financial Officer and Controller
(Principal Financial and
Accounting Officer)
DATE: March 22, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
David W. Dorman,* Chairman of the Board, President and Chief Executive
Officer
Peter A. Darbee, Vice President, Chief Financial Officer and Controller
Gilbert F. Amelio,* Director Lewis E. Platt,* Director
William P. Clark,* Director Toni Rembe,* Director
Herman E. Gallegos,* Director S. Donley Ritchey,* Director
Frank C. Herringer,* Director Richard M. Rosenberg,* Director
Mary S. Metz,* Director
*BY /s/ Peter A. Darbee
-----------------------
Peter A. Darbee, attorney-in-fact
DATE: March 22, 1996
62
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(Dollars in millions)
- ---------------------------------------------------------------------------
Col. A Col. B Col. C Col. D Col. E
- ---------------------------------------------------------------------------
Allowance for Doubtful Accounts
- -------------------------------
Additions
----------------------
(1) (2)
Booked as Charged
Balance at Reductions to Other Balance at
End of Prior to Revenues Accounts Deductions End of
Period (a) (b) (c) Period
- ---------------------------------------------------------------------------
Year 1995 $132 $166 $147 $314 $131
Year 1994 $136 $135 $143 $282 $132
Year 1993 $127 $147 $140 $278 $136
===========================================================================
(a) Provision for uncollectibles as stated in the Consolidated Statements of
Income includes certain direct write-offs which are not reflected in this
account.
(b) Amounts in this column reflect items of uncollectible interstate and
intrastate accounts receivable purchased from and billed for AT&T and
other interexchange carriers under contract arrangements.
(c) Amounts in this column include items written off, net of amounts that had
previously been written off but subsequently recovered.
Reserve for Restructuring
- -------------------------
Additions
----------------------
(1) (2)
Charged Charged
Balance at to Costs to Other Balance at
End of Prior and Expenses Accounts Deductions End of
Period (d) (e) (f) Period
- ---------------------------------------------------------------------------
Year 1995 $ 819 $ - $ - $600 $ 219
Year 1994 $1,097 $ - $ - $278 $ 819
Year 1993 $ 101 $977 $43 $ 24 $1,097
===========================================================================
(d) In 1993 recorded a pre-tax restructuring charge to recognize the
incremental cost of force reductions.
(e) Amounts in this column reflect items capitalized to construction.
(f) The 1995 and 1994 amounts reflect $219 and $62 million of costs,
respectively, for enhanced retirement benefits paid from pension fund
assets which do not require current outlays of the Company's funds.
63
<PAGE>
EXHIBIT INDEX
Exhibits identified in parentheses below as on file with the SEC are
incorporated herein by reference as exhibits hereto. All other exhibits are
provided as part of the electronic transmission.
Exhibit
Number Description
- ------- -----------
3a Articles of Incorporation of Pacific Bell, as amended and restated
to January 11, 1993 (Exhibit (3)a to Form SE filed March 26, 1993 in
connection with the Company's Form 10-K for 1992).
3b By-Laws of Pacific Bell, as amended to February 26, 1996.
4 No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Bell and its subsidiaries is filed
herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A).
Pursuant to this regulation, Pacific Bell hereby agrees to furnish a
copy of any such instrument to the SEC upon request.
2 Computation of Ratio of Earnings to Fixed Charges.
23 Consent of Coopers & Lybrand L.L.P.
24 Powers of Attorney executed by Directors and Officers who signed
this Form 10-K.
27 Financial Data Schedule for Pacific Bell Form 10-K.
64
<PAGE>
Exhibit 3b
----------
BY-LAWS
OF
PACIFIC BELL
(As amended February 26, 1996)
Table of Contents
Article I, Shareholders' Meetings ............................... 1
Article II, The Board of Directors, Directors' Meetings ......... 2
Article III, Executive Committee ................................ 3
Article IV, Officers ............................................ 4
Article V, Chairman of the Board of Directors; Vice Chairmen of the Board
of Directors ................................................. 5
Article VI, President ........................................... 5
Article VII, Powers and Duties .................................. 5
Article VIII, Shares and Share Certificates ..................... 8
Article IX, Annual Reports ...................................... 6
Article X, Seal ................................................. 9
Article XI, Adoption, Amendment, and Repeal of By-Laws........... 6
Article XII, Indemnification of Officers and Directors .......... 7
<PAGE>
BY-LAWS
OF
PACIFIC BELL
(As amended February 26, 1996)
Article I
Shareholders' Meetings
Section 1. The annual meeting of shareholders may be called at any time
between March 1 and July 31 of each year on such day (other than a legal
holiday), at such time and at such place as may be designated by the Board of
Directors, and in the absence of such designation at the principal office of
the corporation, at 10 a.m. on the fourth Friday in April, or, if said day is
a legal holiday, then on the first business day of the following week, to
elect directors and to transact such other business as may properly come
before the meeting. (As amended February 26, 1982)
Written notice of the time and place of said meeting and the business to
be transacted thereat shall be given by the Secretary to the shareholders
personally or by mail, to the extent and in the manner specified by law, at
least ten days but no more than sixty days before the meeting. (As amended
December 22, 1976)
Section 2. Special meetings of the shareholders may be called at any
time by the Chairman of the Board of Directors, if one has been elected, by
the President, by the Board of Directors or by three or more of the directors,
or by any number of shareholders representing not less than ten percent of the
votes entitled to be cast at the meeting, and may be held at any time, whether
on a holiday or not, and at any place. (As amended December 22, 1976)
Written notice of the time and place of said meeting and the business to
be transacted thereat shall be given by the Secretary to the shareholders
personally or by mail, to the extent and in the manner specified by law, at
least ten days but no more than sixty days before the meeting. (As amended
December 22, 1976)
Section 3. At any meeting of shareholders, whether regular or special,
the presence in person or by proxy of shareholders entitled to exercise a
majority of the voting power of the outstanding shares entitled to vote at
such meeting shall constitute a quorum for the transaction of business. (As
amended January 22, 1960)
Section 4. The Board of Directors may fix a time as a record date for
the determination of the shareholders entitled to notice of and to vote at any
meeting of shareholders or entitled to receive any dividend or distribution,
or any allotment of rights, or to exercise rights in respect to any change,
conversion or exchange of shares. The record date so fixed shall not be more
than sixty nor less than ten days prior to the date of the meeting nor more
than sixty days prior to any other event for the purposes of which it is fixed
and only shareholders of record on that date are entitled to notice of and
1
<PAGE>
vote at the meeting or to receive the dividend, distribution or allotment of
rights or to exercise the rights, as the case may be. (As amended
December 22, 1976)
Article II
The Board of Directors, Directors' Meetings
Section 1. The number of directors shall be fixed at 10 until changed by
resolution of the Board of Directors but at no time shall be less than 9 nor
more than 17 until changed by amendment of these By-Laws. The Board of
Directors shall be elected by the shareholders at the annual meeting or at any
other meeting held for that purpose, and directors shall hold office until the
next annual election and until their successors are elected. Any vacancy or
vacancies in the Board of Directors may be filled by a majority of the
remaining directors. (As amended March 10, 1994)
Section 2. Regular meetings of the Board of Directors may be held
without notice at such time and place as shall from time to time be determined
by the Board and no notice of such meeting shall be necessary to the newly
elected directors in order legally to constitute the meeting, provided a
quorum shall be present. (As amended July 28, 1989)
Section 3. Special meetings of the Board of Directors may be called by
the Chairman of the Board or the President, or a Vice Chairman, and shall be
called by the Chairman of the Board, the President or Secretary on the written
request of a majority of the directors. Notice of special meetings shall be
given by the Secretary or Assistant Secretary of the corporation to each
director personally or by telephone, facsimile transmission or telegram at
least 48 hours before the meeting, or by mailing written notice at least four
days before the meeting. (As amended November 20, 1992)
Section 4. Six members of the Board of Directors shall constitute a
quorum at any meeting. (As amended August 5, 1948)
Section 5. The Board of Directors may, by resolution adopted by a
majority of the authorized number of directors, designate one or more
committees, each consisting of two or more directors, to serve at the pleasure
of the Board. The Board may designate one or more directors as alternate
members of any committee, who may replace any absent member at any meeting of
the committee. Any such committee, to the extent provided in the resolution
of the Board or in the By-Laws, shall have all the authority of the Board,
except with respect to those powers enumerated in Article III, Section 2 of
these By-Laws.
Unless other procedures are established by resolution adopted by the
Board, the provisions of Sections 2 and 3 of this Article II shall be
applicable to committees of the Board of Directors, if any are established.
For such purpose, references to "the Board" or "the Board of Directors" shall
be deemed to refer to each such committee. The committees shall keep regular
minutes of their proceedings and report the same to the Board when required.
2
<PAGE>
A majority of the committee members at a meeting duly assembled shall be
necessary to constitute a quorum for the transaction of business and the act
of a majority of the committee members present at any meeting at which a
quorum is present shall be the act of the committee. Any action required or
permitted to be taken at a meeting of the committee may be taken without a
meeting if a consent in writing, setting forth the action so taken, shall be
signed by all of the committee members entitled to vote with respect to the
subject matter thereof. (As amended July 28, 1989)
Article III
Executive Committee
Section 1. The Executive Committee, if one is appointed, shall consist
of two or more directors. The remaining directors shall be alternate members
of the Executive Committee, and, in the absence or disability of any regular
member of the Executive Committee, any such alternate member may be called by
the Chairman or by the President to serve in the place of such absent or
disabled regular members. (As amended February 26, 1996)
Section 2. The Executive Committee may exercise all the powers of the
Board of Directors during the intervals between meetings of the Board, except
the powers to:
(a) Approve any action which under the General Corporation Law also
requires shareholders' approval or approval of the outstanding shares.
(b) Fill vacancies on the Board or on any committee.
(c) Fix the compensation of the directors for serving on the Board
or on any committee.
(d) Adopt, amend, or repeal By-Laws.
(e) Amend or repeal any resolution of the Board which by its
express terms is not so amendable or repealable.
(f) Cause a distribution to the shareholders, except at a rate or
in a periodic amount or within a price range determined by the Board.
(g) Appoint other committees of the Board or the members thereof.
(As amended December 22, 1976)
Section 3. Meetings of the Executive Committee may be called for any
time and place by the Chairman of the Board of Directors, if one has been
elected, or by the President.
Section 4. Notice of a meeting of the Executive Committee shall be given
by the Secretary or an Assistant Secretary of the corporation to each members
personally or by telephone, facsimile transmission or telegram at least
48 hours before the meeting or by mailing written notice at least four days
before the meeting. As amended November 20, 1992)
3
<PAGE>
Section 5. A Majority of the Executive Committee shall constitute a
quorum at any meeting. All actions taken at meetings of the Committee shall
be recorded, and shall be reported to the Board of Directors from time to
time.
ARTICLE IV
Officers
The officers of the corporation shall be elected by the Board of
Directors and shall hold office at the pleasure of the Board. The Chairman of
the Board shall not be an officer of the corporation. The officers of the
corporation shall consist of such Vice Chairmen of the Board as the Board of
Directors may elect, a President, such Executive Vice Presidents, such Senior
Vice Presidents and such Vice Presidents as the Board may elect, a Secretary,
a Treasurer, a Controller, such Assistant Secretaries and Assistant Treasurers
as the Board may elect, and such other officers as the Board may elect. The
Board of Directors shall designate one officer of the corporation as the Chief
Financial Officer. (As amended February 8, 1996)
ARTICLE V
Chairman of the Board of Directors;
Vice Chairmen of the Board of Directors
Section 1. The Chairman of the Board of Directors shall preside at all
meetings of the Board of Directors, of the Executive Committee and of the
shareholders and have such authority and shall perform such other duties as
the By-Laws establish or as the Board of Directors may from time to time
assign. (As amended January 27, 1984)
Section 2. Each Vice Chairman of the Board shall have such powers and
shall perform such duties as may from time to time be assigned by the Board of
Directors or as the Chairman of the Board of Directors may from time to time
delegate or direct. (As amended July 28, 1989)
ARTICLE VI
President
The President shall be the Chief Executive Officer of the corporation and
shall have such powers and shall perform such duties as may from time to time
be assigned by the Board of Directors or as the Chairman of the Board may from
time to time delegate or direct. (As amended January 27, 1984)
ARTICLE VII
Powers and Duties
Each officer of the corporation shall have such powers and perform such
duties as the Board of Directors or the Chairman of the Board may from time to
time delegate or direct. The Board of Directors or the Chairman of the Board
may delegate to certain officers the power to define the authority and powers
of other officers. (As amended July 14, 1987)
4
<PAGE>
ARTICLE VIII
Shares and Share Certificates
Section 1. The certificates for the shares of the corporation shall be
in form and content as required by law and as approved by the Board of
Directors.
Section 2. The corporation shall not issue any certificate evidencing,
either singly or with other shares, any fractional part of or interest in a
share.
Section 3. The person, firm, or corporation in whose name shares stand
on the books of the corporation, whether individually or as trustee, pledgee
or otherwise, may be recognized and treated by the corporation as the absolute
owner of the shares, and the corporation shall in no event be obliged to deal
with or to recognize the rights or interests of other persons in such shares
or in any part thereof.
ARTICLE IX
Annual Reports
An annual report shall be sent to the shareholders not later than one
hundred twenty days after the close of the fiscal year, but at least fifteen
days prior to the next annual meeting of shareholders to be held during the
next fiscal year. (As amended December 22, 1976)
ARTICLE X
Seal
The corporate seal shall have inscribed thereon the name of the
corporation, the year of its organization and the State within which it is
incorporated. The seal may be used by causing it or a facsimile thereof to be
impressed or affixed or reproduced or otherwise. (As amended November 20,
1992)
ARTICLE XI
Adoption, Amendment, and Repeal of By-Laws
These By-Laws may be amended or repealed or new by-laws may be adopted by
the vote of shareholders entitled to exercise a majority of the voting power
of the corporation or by the written assent of such shareholders filed with
the Secretary. Subject to the right of the shareholders to amend or repeal
these By-Laws, or to adopt new by-laws, the Board of Directors may adopt,
amend or repeal any by-law other than Article II, Section 1 hereof. (As
amended November 25, 1953)
5
<PAGE>
ARTICLE XII
Indemnification of Officers and Directors
This corporation shall, to the maximum extent permissible under
applicable common or statutory law, state or federal, indemnify each of its
agents against expenses, judgments, fines, settlements and other amounts
actually and reasonably incurred in connection with any proceeding arising by
reason of the fact that any such person is or was an agent of this
corporation. For purposes of this Article XII, an "agent" of this corporation
includes any person who is or was a director or officer of this corporation,
or who is or was serving at the request of this corporation as a director,
officer, employee or agent of another corporation, partnership, joint venture,
trust or other enterprise.
Prior to the disposition of any such proceeding, this corporation, upon
the request of any such agent, shall promptly advance to such agent, or
otherwise as directed by such agent, such amounts as shall be equal to the
expenses which shall have been incurred by such agent in defending such
proceeding, provided that such agent requesting such amounts shall first have
delivered to this corporation an undertaking to repay any and all such
advances unless it shall be determined ultimately that such agent is entitled
to be indemnified with respect thereto in accordance with this Article XII.
(As amended February 28, 1986)
6
<PAGE>
Exhibit 12
----------
PACIFIC BELL AND SUBSIDIARIES
RATIO OF EARNINGS TO FIXED CHARGES
(Dollars in millions)
-----------------------------------------------
1995 1994 1993 1992 1991
------ ------ ------ ------ ------
1. Earnings
--------
(a) Income before
Interest Expense $1,379 $1,510 $ 447 $1,591 $1,427
(b) Federal Income
Taxes 421 462 (68) 458 416
(c) State and local
Income Taxes 148 159 11 149 157
(d) 1/3 Operating
Rental Expense 28 40 37 35 33
------- ------- ------- ------- ------
Total $1,976 $2,171 $ 427 $2,233 $2,033
2. Fixed Charges
-------------
(a) Total Interest
Deductions $ 410 $ 439 $ 429 $ 460 $ 485
(b) 1/3 Operating
Rental Expense 28 40 37 35 33
------- ------- ------- ------- -------
Total $ 438 $ 479 $ 466 $ 495 $ 518
3. Ratio (1 divided by 2) 4.51 4.53 .92* 4.51 3.92**
* This figure reflects the restructuring and curtailment charges totaling
$924 million after taxes taken in the fourth quarter 1993.
** This figure reflects the restructuring charges of $121 million after taxes
taken in fourth quarter 1991.
<PAGE>
Exhibit 23
----------
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference of our report dated
February 22, 1996, on our audits of the consolidated financial statements and
the financial statement schedule of Pacific Bell and Subsidiaries as of
December 31, 1995 and 1994, and for each of the three years in the period
ended December 31, 1995, which report is included in this Annual Report on
Form 10-K, and in Pacific Bell's registration statement as follows:
Form S-3: Pacific Bell $1.575 Billion Debt Securities
/s/ COOPERS & LYBRAND L.L.P.
San Francisco, California
March 22, 1996
<PAGE>
Exhibit 24
----------
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS:
WHEREAS, PACIFIC BELL, a California corporation (the "Company"), proposes to
file with the Securities and Exchange Commission (the "SEC"), under the
provisions of the Securities Act of 1934, as amended, an Annual Report on
Form 10-K; and
WHEREAS, each of the undersigned is a director of the Company;
NOW, THEREFORE, each of the undersigned, hereby constitutes and appoints D. W.
Dorman, W. E. Downing, P. A. Darbee and R. W. Odgers, and each of them,
his/her attorney for him/her in his/her stead, in his capacity as a director
of the Company, to execute and to file such Annual Report on Form 10-K, and
any and all amendments, modifications or supplements thereto, and any exhibits
thereto, and granting to each of said attorneys full power and authority to
sign and file any and all other documents and to perform and do all and every
act and thing whatsoever requisite and necessary to be done as fully, to all
intents and purposes, as he/she might or could do if personally present at the
doing thereof, and hereby ratifying and confirming all that said attorneys may
or shall lawfully do, or cause to be done, by virtue hereof in connection with
effecting the filing of the Annual Report on Form 10-K.
IN WITNESS WHEREOF, each of the undersigned has hereunto set his/her hand this
22nd day of March, 1996.
/s/ Gilbert F. Amelio /s/ Lewis E. Platt
Director Director
/s/ William P. Clark /s/ Toni Rembe
Director Director
/s/ Herman E. Gallegos /s/ S. Donley Ritchey
Director Director
/s/ Frank C. Herringer /s/ Richard M. Rosenberg
Director Director
/s/ Mary S. Metz
Director
1
<PAGE>
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS:
WHEREAS, PACIFIC BELL, a California corporation (the "Company"), proposes to
file with the Securities and Exchange Commission (the "SEC"), under the
provisions of the Securities Act of 1934, as amended, an Annual Report on
Form 10-K; and
WHEREAS, each of the undersigned is an officer or director, or both, of the
Company, as indicated below his name;
NOW, THEREFORE, each of the undersigned, hereby constitutes and appoints D. W.
Dorman, W. E. Downing, P. A. Darbee and R. W. Odgers, and each of them, his
attorney for him in his stead, in his capacity as an officer or director, or
both, of the Company, to execute and file such Annual Report on Form 10-K, and
any and all amendments, modifications or supplements thereto and any exhibits
thereto, and granting to each of said attorneys full power and authority to
sign and file any and all other documents and to perform and do all and every
act and thing whatsoever requisite and necessary to be done as fully, to all
intents and purposes, as he might or could do if personally present at the
doing thereof, and hereby ratifying and confirming all that said attorneys may
or shall lawfully do, or cause to be done, by virtue hereof in connection with
effecting the filing of the Annual Report on Form 10-K.
IN WITNESS WHEREOF, each of the undersigned has hereunto set his hand this
22nd day of March 1996.
/s/ David W. Dorman
Chairman of the Board,
President and Chief Executive Officer
/s/ Peter A. Darbee
Vice President, Chief Financial Officer and Controller
2
<TABLE> <S> <C>
<PAGE>
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<MULTIPLIER> 1,000,000
<S> <C>
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> DEC-31-1995
<PERIOD-TYPE> 12-MOS
<CASH> 68
<SECURITIES> 0
<RECEIVABLES> 1,606
<ALLOWANCES> 131
<INVENTORY> 0
<CURRENT-ASSETS> 2,345
<PP&E> 26,688
<DEPRECIATION> 15,608
<TOTAL-ASSETS> 13,899
<CURRENT-LIABILITIES> 3,442
<BONDS> 4,608
<COMMON> 225
0
0
<OTHER-SE> 2,886
<TOTAL-LIABILITY-AND-EQUITY> 13,899
<SALES> 0
<TOTAL-REVENUES> 8,862
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 6,939
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<INTEREST-EXPENSE> 410
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